Abstract
The paper analyzes the failure of the common European monetary policy based on a Mises-Hayek overinvestment framework. It is shown how since the turn of the millennium an overly expansionary monetary policy contributed to unsustainable overinvestment booms in the southern and western periphery of the European Monetary Union and more recently in Germany. To explain idiosyncratic business cycles within the euro area before and since the outbreak of the European financial and debt crisis, the overinvestment theories are combined with the literature on optimum currency areas and on the role of fiscal policies in a monetary union. It is shown that the ECB’s ultra-loose monetary policy as a crisis therapy puts a drag on long-term growth in Europe by conserving distorted economic structures, which is seen as a risk for the whole European integration process. Therefore, a timely exit from the ultra-expansionary monetary policy is recommended.
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Notes
- 1.
Hayek (1929) and Wicksell (1898) had different concepts of the natural interest rate. According to Wicksell (1898), the deviation of the central bank and capital market interest rates from the natural rate of interest disturbs the equilibrium between ex ante savings (S) and investment (I) plans. This leads to inflationary (I > S) or deflationary pressure (S > I). During a credit boom the supply of goods cannot satisfy the additional demand for goods at given prices, which leads to inflation. Mises (1912) and Hayek (1929) explained business cycles by the deviation of the central bank (capital market) interest rate from the natural rate of interest. Hayek emphasized the importance of the intertemporal alignments of plans of producers and consumers to explain overinvestment as a mismatch between the production structure and consumer preferences. The natural interest rate is the interest rate which aligns saving and consumption preferences with the production structure over time.
- 2.
As Deutsche Bundesbank did not depreciate the German mark in response to the depreciation of the southern European currencies, destabilizing competitive depreciations were prevented.
- 3.
The Baltic countries have, however, achieved a high degree of labor market and fiscal flexibility.
- 4.
With the business cycle being inversed at a later point of time, the mechanism is inversed as well.
- 5.
According to Art. 126 TFEU “(1) Member States shall avoid excessive government deficits. (2) The Commission shall monitor the development of the budgetary situation and of the stock of government debt in the Member States with a view to identifying gross errors. In particular it shall examine compliance with budgetary discipline...”
- 6.
In the United States, similar interest rate cuts nurtured a speculation boom in the real estate market, which led into the subprime crisis.
- 7.
The Taylor rule as a tool to provide an appropriate benchmark for central bank interest rate setting should be treated with caution, because the transmission of monetary policymaking toward consumer price inflation has become increasingly disturbed since the mid-1980s. Incorporating the effects of monetary policy on asset prices would deliver even higher Taylor rule target rates.
- 8.
After the introduction of the euro, the general government budget deficit fell below the −3% of GDP Maastricht limit. This was partially due to the reforms, which slowed down growth and thereby reduced tax revenues.
- 9.
As the reduction of future pensions was paired with incentives for private provisions for retirement, savings of the private sector increased. The resulting dramatic rise of aggregate savings over investment contributed to the significant rise in capital outflows.
- 10.
In Germany, real wage increases were lagging behind productivity increases in the respective time period.
- 11.
As, for instance, made possible by the so-called emergency liquidity assistance (ELA).
- 12.
After the European Central Bank had cut interest rates toward zero, it embarked on several bond purchase programs such as the Securities Markets Program (SMP, May 2010 to September 2012, 211 billion euros) and the Outright Monetary Transactions Program (OMT, from July 2012), which was up to today not activated, but included the promise to undertake “whatever it takes” to keep the euro area together. Two Covered Bond Purchase Programs (CBPP1, 60 billion euros from July 2009 to June 2010; CBPP2, 16.4 billion euros from November 2011 to October 2012) expanded the ECB balance sheet. In January 2015, the Asset Purchase Program (APP) was announced, which included the previously launched Covered Bond Purchase Program 3, the Asset-Backed Securities Purchase Program (ABSPP), and the Public Sector Purchase Program (PSPP). The APP allowed purchases of government and corporate sector bonds of up to 80 billion euros per month. Up to March 2017 the aggregated purchase volume was 1740 billion euros. The purchase program was extended with a smaller scale of 60 billion euros per month to December 2017 bringing the overall volume of (government) bond purchases to 2250 billion euros. The purchase programs not only held the money market rate at zero, they also depressed the interest rates at the longer end of the yield curve. This significantly reduced the interest rate burden for over-indebted governments in the euro area, which can be seen to be against Art. 127 of TFEU.
- 13.
ANFA is equivalent to a regional monetary policy within a one-size monetary policy framework.
- 14.
Note that according to the balance of payment identity, in the absence of public capital flows, the current account is equivalent to the financial account with inversed sign. Given public capital flows, the sum of private and public capital flows has to match the current account balance with inversed sign.
- 15.
That is, credit provided by a German bank to a Greek bank.
- 16.
In addition, the low interest rate and the unconventional monetary policy measures depress the margin between long-term and short-term interest rates (transformation margin). Furthermore, the margin between the money market rate and the deposit rate is pushed toward zero.
- 17.
The declining financing costs of enterprises become visible in growing enterprise savings, which has for instance turned positive in Japan and Germany. The rise in enterprise savings corresponds to a decline in household savings. It is difficult to provide empirical evidence for the hypothesis of a global liquidity glut as launched by Bernanke (2005), because the assumed structural increase in net household savings of aging societies cannot be observed in any of the aging countries with surplus savings such as Germany, Japan, and China. Instead of fixed capital formation, large enterprises tend to invest in financial or real estate markets, where central banks provide a quasi-insurance mechanism against losses. Increasingly, own shares are bought back, because alternative investment categories (bank deposits, government bonds) render low yields due to the asymmetric monetary policy crisis management.
- 18.
Kornai (1986) characterized the situation in the central and eastern European economies before 1990 as soft budget constraints: unprofitable enterprises were kept alive by credit provision of the state-owned banking sector to avoid unemployment. As savings at state-owned banks were not large enough to cover the financing needs of enterprises, the funds were created by the central bank via the printing press.
- 19.
This interpretation is in line with Borio (2014), who identifies capital overhang as a major determinant of post-bubble crisis.
- 20.
- 21.
Which assumes constant production costs in different types of markets.
- 22.
Borio et al. (2016) show the negative impact of credit booms on the allocation of labor and productivity gains.
- 23.
Therefore, the share of Germans living in their own flat or house is small compared to southern European countries, where inflation has been traditionally high.
- 24.
On details see Belke et al. (2016).
- 25.
Like in the current crisis countries prior to the crisis, the bubble in Germany currently inflates tax revenues.
- 26.
Positive trade balances are seen as proxy for net capital exports.
- 27.
Because fiscal policies have a direct impact on investment activity, relative fiscal policies stances—in particular in interaction with loose monetary policy stances—constitute an important determinant of current account balances. See Wollmershäuser and Schnabl (2013) for Europe and Duarte and Schnabl (2015) for larger sample of 86 emerging markets and industrialized countries.
- 28.
For instance, German credit provision to the southern and western European countries and to the US subprime boom has turned sour.
- 29.
For details see Hoffmann and Schnabl (2016).
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Acknowledgments
I thank Raphael Fischer und Taiki Murai for excellent research assistance. I thank the Friedrich August von Hayek Foundation and Jackstädt Foundation for financial support.
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Schnabl, G. (2018). The Failure of ECB Monetary Policy from a Mises-Hayek Perspective. In: Godart-van der Kroon, A., Vonlanthen, P. (eds) Banking and Monetary Policy from the Perspective of Austrian Economics. Springer, Cham. https://doi.org/10.1007/978-3-319-75817-6_7
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