Is temporary inflation the solution to the European crisis?

[jules.LT]

Inflation is usually not desirable, but the alternative seems worse: excessive austerity stifles growth and makes a recovery even more improbable.
After reading two very interesting articles on the subject (in French, unfortunately), I'm increasingly convinced that the only way out of this crisis is with inflation, through massive ECB purchases of government bonds.

I find the arguments I've seen against it unconvincing, and I wonder if those I'll see here will fare better...

[CorruptUser]

Sort of. Inflation is the way to eliminate insurmountable debts. But it comes at the cost of few ever willing to lend you money again, as well as the risk of hyperinflation and the costs associated with that. It's only even a viable option when the government would be stable except for the debt burden, which is not the case in Greece or Italy; those countries can't pay their bills no matter what they do. Or the US for that matter; interest on debt makes up only $200B of a $1.4T deficit.

[Zamfir]

It is actually the case for Italy, which runs a primary surplus. Despite stereotypes, Italy is fairly good at managing its debt. Italian debt over GDP has been roughly constant in the last 20 years, and it's real interest rates tended to be highs but not extremely so, even in the days of ritual lire devaluation.

On the issue of the ECB buying debt: in the end, it's just a tax. One where it's hard to pinpoint agony exactly pays and when, which makes it always a politically attractive tax, and Why it's currently feasible while other eurozone central taxes are not.

And there are good rguments that it is currently the best kind of tax, because it taxes a preference for liquidity and we have too much of that preference. Or because inflation makes it easier to drive down wages, or because stimulative effects would pay part of the tax through increased production.

But in the end it's still a central European tax levied through a decision structure that is not very accountable to the people. Either the ECB gets high freedom to choose which bonds to buy, so the bankers become the determiner who gets the tax proceedings. Or we want close political control over their policies (like usually in such policies), but then the leadership structure of the ECB must be changed. Or national politicians negotiate a strict policy on which mix of bonds to buy or at what rates. That makes it highly attractive for countries to game the system by issuing more debt, unless that gets checked by another central power.

It might well be thtr best way forward, and some form of centralized economic policy is perhaps unavoidable anyway, at least in the short run.But budget and tax policy tends to bring other powers, and I doubt there would be much of a way back.

Which brings us back to Italy and its central bank, with about 40 years of experience of using debt and inflation as a hidden tax when formal taxes got in political quagmire, and who turned that into an effective art form. It would be highly amusing if the ECB of the 21st century follows that lead, instead of being the Bundesbank but bigger and harder. Presumably t will end up somewhere in between, like so many European institutes turn French because the Germans are too German and the Brits pretend to be a continent of their own.

[Deep_Thought]

Presumably it will end up somewhere in between, like so many European institutes turn French because the Germans are too German and the Brits pretend to be a continent of their own.

Oh come on, there's water in between us and everything. If those damn Frenchies hadn't dug a tunnel under our moat we'd still be just our little Island, born to rule the waves, born to rule the EMPIRE!

Sorry, I don't know what came over me. Serious face back on.

I am also of the opinion that unfortunately inflation seems to be the best, maybe only, route available for Europe (and the UK, and probably the US as well). Given that the ECB and Bank of England are continuing Quantitative Easing programmes (almost under the table in the ECB's case) it would appear that the central banks also agree. The tricky bit, as always, is to make sure it doesn't get out of hand. Germany in particular hates inflation, which is why price control is, as I understand it, the central part of the ECB's mandate.

It might well be thtr best way forward, and some form of centralized economic policy is perhaps unavoidable anyway, at least in the short run.But budget and tax policy tends to bring other powers, and I doubt there would be much of a way back.

I kind of think the Eurozone has reached tipping point - either there's going to be more integration of economic policy, or it will start to fall apart. But I'm aware that people often say this kind of thing and there's sure to be a few more lurches in both directions before the dust settles.

[Zamfir]

Oh come on, there's water in between us and everything. If those damn Frenchies hadn't dug a tunnel under our moat we'd still be just our little Island, born to rule the waves, born to rule the EMPIRE!

Goldman Sachs owns the channel tunnel. Tinfoil hats on in 3,2,1 seconds.

[CorruptUser]

The Chunnel is owned by 'Sachs, Deutsche, and Citigroup. Not quite same as being owned solely by Goldman Sachs.

The idea that tinfoil hats protect your brain is a myth propagated by the shadow government. Just stick with nice, protective lead. The whole banning lead in fuel and paint is there to make it easier to mind-rape us.

[Zamfir]

Good to know there's also responsible people involved. Perhaps RBS can buy a share as well.

[Yakk]

Public policy over this recession has been dominated by attempting to keep things flush for "renters" of money. Which makes lots of sense, because the renters of money have lots of money (by definition), and it is in their self interests to be generous to politicians and bureaucrats who ensure that their money remains safe.

The world has been engaged in massively inflationary policies -- the amount of money they injected into the world economy is pretty ridiculous. Most of this money was aimed directly at money-renters (banks and the like), preventing them from having to pay the downside of the bets they made (and protecting their non-insured counter-parties, mainly other renters of money).

The deflationary pressure of the recession has been mostly countered by these huge inflationary actions. Note that other inflationary actions might have worked as well, without benefiting money-renters quite as directly (ie, simply printing currency and handing it out is an inflationary action, where the direct beneficiaries are the people who are handed money rather than the banks getting bailouts).

Real inflation, as opposed to inflationary actions that counter deflationary pressures, would harm money renters. The money they get back would be worth less than the money they lent out. As money renters are powerful people, why would governments want to do that? Instead, harm those with less power, and accept kickbacks in the form of post-politics jobs, political campaign donations, and consulting contracts for a million dollars for services you can't even remember, from those money renters.

Note that the inflationary acts of the governments have harmed the money renters, but by funneling the inflationary money through said renters, the harm was more than mitigated. Profits for the financial industry went up after the initial downward spike at the start of the recession.

A good political move is one that harms people without tools to fight back, not one that creates enemies which are powerful.

In order to generate enough inflation to mitigate the debt problem in a politically acceptable way, you'd have to throw so much money at money renters that it would generate ridiculous profits for them, and the ensuing harm to the rest of society would be as big or bigger than the austerity measures.

Or maybe it would work. I mean, it has in a few cases in the past (where a nation has inflation-defaulted, or even just strait defaulted, their way out of a financial problem). Having a structural surplus is important for this to work.

Greek austerity measures are, as an example, at least somewhat a consequence of wanting more from the state than the Greek population is putting into the state. Some austerity is sort of required -- but not as much as the money renters want.

[Deep_Thought]

As money renters are powerful people, why would governments want to do that?

While normally I more cynical than the next man, you are forgetting that the money supply is controlled by central banks, not governments. While the separation between the two is not as rigorous as perhaps it should be, the fact remains that the ECB, Bank of England and even the Fed are not directly answerable to either their governments or people. Most Western nations have deliberately separated their central banks out from the government, in order to avoid the kind of populist monetary policy that seriously screws with nation's economies.

Profits for the financial industry went up after the initial downward spike at the start of the recession.

This is mainly an artefact of Mark-to-Market accounting (which I am hugely critical of). You own an asset. In 2007 it is worth $X. In 2008 it is worth $(X / 2). You have to report a 50% loss. In 2009 it is worth $(3 X / 4). You have to report a 50% profit. Now that asset prices have (I'm generalising) flatlined or declined for the last year or so, plenty of financial institutions are back to reporting losses.

[Zamfir]

While normally I more cynical than the next man, you are forgetting that the money supply is controlled by central banks, not governments. While the separation between the two is not as rigorous as perhaps it should be, the fact remains that the ECB, Bank of England and even the Fed are not directly answerable to either their governments or people. Most Western nations have deliberately separated their central banks out from the government, in order to avoid the kind of populist monetary policy that seriously screws with nation's economies.

And that's good thing? The underlying assumption of that separation was that central banking had become a technical matter, with fairly clear goals and only small technical disputes over the exact path to achieve them. That's currently nowhere near the truth.

They are essentially deciding over direct industrial policy for the entire banking sector, choosing which institutes are allowed to survive and how much profits they are allowed to make, implicitly using government funds to make up the difference when necessary. Since they decide which investments they will accept as collateral, they are directing investment into and out of other sectors of the economy. And from the looks of it, the ECB is now becoming the effective treasury department of the EU, deciding how much money national governments are allowed to spend and cutting that if those countries do not enact the policies that the ECB deems necessary.

That's a lot of power. There's no need for conspiracy theories to be worried about that kind of power in the hands of unelected and badly supervised boards of experts. And central bankers really are bankers. They have been part of the financial world for decades, sometimes a bit on the outside of the private sector, sometimes more in it. It comes natural to them to see the health of the financial sector as of primary importance, to use measures from that system as yardstick to judge the overall state and direction of the economy to guide new actions.

That's not necessarily bad will, far from it. It's just that people's backgrounds colour their views. Democracy is not just a check on outright selfish corruption, it's also a mechanism to push the interests of ordinary people to the foreground, to break into the incrowd smallness of technocrats.

[Deep_Thought]

And from the looks of it, the ECB is now becoming the effective treasury department of the EU, deciding how much money national governments are allowed to spend and cutting that if those countries do not enact the policies that the ECB deems necessary.

From what I understand of the ECB's recent actions, they have only intervened once it has become clear that no-one else will step in. You're right that it is a huge amount of power, but I don't think that the people at the head of the ECB actually wants it. Maybe I'm reading it wrong, but I think the ECB would prefer EU politicians to grow some testicles and actually start making the kind of decisions that would mean they no longer have to intervene. Such as creating an EU treasury so they don't have to do the job...

And central bankers really are bankers.

Not always. Mervyn King is an academic (Which may be worse...)

Democracy is not just a check on outright selfish corruption, it's also a mechanism to push the interests of ordinary people to the foreground, to break into the incrowd smallness of technocrats.

The current prevailing view among those in power seems to be "Democracy will last until the public realizes that it can vote itself largesse from the public trough". The Bank of England in particular was granted interest rate setting powers only in 1998, after the Tories had messed it up so thoroughly in the early 90s mainly due to populist demands.

[CorruptUser]

Populist policies breaking the government? Like the policy of trying to get as many people to own homes regardless of their actual ability to afford it? Or the policies of giving as many people as possible a college education, assuming large mountains of debt, regardless of whether or not the degree is actually useful? Shocking!

[Zamfir]

From what I understand of the ECB's recent actions, they have only intervened once it has become clear that no-one else will step in. You're right that it is a huge amount of power, but I don't think that the people at the head of the ECB actually wants it. Maybe I'm reading it wrong, but I think the ECB would prefer EU politicians to grow some testicles and actually start making the kind of decisions that would mean they no longer have to intervene. Such as creating an EU treasury so they don't have to do the job...

Perhaps, yes. Though not wanting power doesn't mean you don't have it. And not using a power can be a choice as well. In particular, the ECB is far less modest when it comes to provision of funds for banks. Look at their holdings of collateral, which includes hundreds of billions of bank bonds and even some highly dubious stuff from when the crisis was high in 2008, 2009. When it comes to banks, the ECB doesn't seem to have that prudent distaste to use their powers that they show with respect to governments.

Which makes me suspect that that distaste is not just prudent avoidance of power, but also an active choice for austerity policies that result from it, which is the kind of choice that elected politicians should make, not unelected officials.

[Deep_Thought]

Yes, I totally agree that kind of decision should be made by politicians. Hopefully the EU will actually get its act together and start making such decisions.

You make an interesting point about the difference between the ECB funding banks and countries. I was about to write about the ECB being the "Lender of Last Resort" to European banks, and then I remembered that the ECB explicitly is supposed not to be the lender of last resort. Oh the joys of the EU...

[jules.LT]

Which makes me suspect that that distaste is not just prudent avoidance of power, but also an active choice for austerity policies that result from it, which is the kind of choice that elected politicians should make, not unelected officials.

Then again, without the ECB's relative independence and anti-inflation obsession to keep us in check, I'd be MUCH LESS comfortable about going into any level of inflation :-/

Those unelected officials are still nominated by politicians, that's some level of control... Although I'm not sure whether even the current backlash against finance would be enough to turn the choice away from people who put an excessive emphasis on the banking system.

In the end, the politicians of Europe have the power to make the ECB what they want... they just need the balls to do it

[jules.LT]

I was told by someone whose opinion I usually respect that... the European debt is mostly in dollars??
That would make inflation counter-productive...
I can't find any source to back that, but then again I can't find any source saying the opposite. Care to help?

Edit: scratch that, I'm getting there. On Eurostat.
Edit: here it is. Euro area countries usually have 90⁺% of their debt labelled in euros
(can't find France in there, though I'll have to dig further)
Edit: on the other hand, a significant (but not major) portion of our debts is indexed on inflation. That's almost 10% of the debt issued in "OAT€i" in France in 2005 (source in French)

[Deep_Thought]

Edit: here it is. Euro area countries usually have 90+% of their debt labelled in euros

Yes, this sounds more right to me, since the introduction of the Euro.

However prior to that it may have been the case that the a lot of European debt was in dollars - "Eurobonds" already exist, but the name used to mean a dollar-denominated loan issued by a European country. Even more confusingly, they were/are often arranged by London banks. It's simply down to the fact that from the end of WW2 up until the last decade or so the Almighty Greenback was the only currency international investors actually wanted.

[Zamfir]

Edit: on the other hand, a significant (but not major) portion of our debts is indexed on inflation. That's almost 10% of the debt issued in "OAT€i" in France in 2005 (source in French)

Does that really matter a lot? If the ECB buys government debt with new euros, then (net) government debts are reduced anyway. After all, the ECB is in the end owned by the governments.

[Deep_Thought]

Is net government debt reduced? I assumed that even if the ECB buys a government bond, the government still has to pay the interest on it. So the ECB buying a bond does not reduce the number of outstanding bonds. The ECB stepping in does two things - provides assured temporary liquidity in the form of cash right now, and drives down long-term costs by decreasing the yield, and hence the interest rate on any new bond issue. Or have I missed something?

[Zamfir]

Government pays to the ECB -> profit for ECB -> money for governments. With the complications of shared ownership of course, but the general principle holds.

[jules.LT]

Government pays to the ECB -> profit for ECB -> money for governments. With the complications of shared ownership of course, but the general principle holds.

Is that so? I thought the Central Bank just erased the debt (it's not like it *needs* euros: it can summon them at will).
Otherwise, I don't see how liquidity would be transferred back from the ECB to the individual governments.

[Zamfir]

The central bank wants a certain amount of debts they owe others on their balance sheet, since those debts are euros, by definition. They also want a certain, larger, amount of assets on their balance sheet, because they might have to sell those assets when they want to lower the amount of euros outstanding.

So if they get euros, as interest for example, they won't keep them since that would lower the number of euros outstanding. They either use them to get more assets, and when they have enough assets they hand the euros over to their owners as dividend.

[Ixtellor]

Just to counter something said previously...

I think the Central Banks have done a good job, with the exception that they became overly influenced by governments.
Clinton and Bush Jr put huge pressures on our Fed to keep interest rates low. (Don't rock the boat why shes a cooking!) which caused banks to (incentivized by nearly free money) give out all kinds of risking home/business loans. (See Housing Bubble, See Dot.Com bubble)

Had the Fed been allowed to act as it knew it should (raise interest rates during the growth periods) it might have prevented the 08 collapse and the dot.com collapse.

[jules.LT]

Had the Fed been allowed to act as it knew it should (raise interest rates during the growth periods) it might have prevented the 08 collapse and the dot.com collapse.

The thing is: the ECB seems to be doing the exact opposite mistake by keeping money tight in a crisis.

[Ixtellor]

Had the Fed been allowed to act as it knew it should (raise interest rates during the growth periods) it might have prevented the 08 collapse and the dot.com collapse.

The thing is: the ECB seems to be doing the exact opposite mistake by keeping money tight in a crisis.

Thats probably because they need the PIGS to enact reform and realize any easy money is just going to be wasted, particularly in Greece.
(I am far less versed in Portugal and Spains financial mishandlings, but feel well informed on Greece, Ireland, and to a degree France and the their longterm fiscal problems)

Interesting topic... did you know that Ireland voluntarily bankrupted their nation, when they had the opportunity to easily dodge the banking crisis? Crazy ass Irish people.

[Whimsical Eloquence]

Interesting topic... did you know that Ireland voluntarily bankrupted their nation, when they had the opportunity to easily dodge the banking crisis? Crazy ass Irish people.

Do you mean the Government Guarantee of all Assets, including all bond categories? It was something of a snap decision made after a night in which several senior members approached the then Minister of Finance and more or less gave the impression that calamity (read: large scale runs on bank/ liquidity crisis) would fall if the Government didn't take action to insure liquidity and national/international confidence.

[Zamfir]

Thats probably because they need the PIGS to enact reform and realize any easy money is just going to be wasted, particularly in Greece.

But who are they to decide who has to enact reforms? If the ECB takes actions that they do not consider beneficial in themselves, but instead in order to push through their political views, then we need far stricter democratic oversight of the ECB.

Independent central banking rests on the assumption that the central bank will not take such political decisions, but can stick to technocratic decisions. That doesn't seem to be the case here, if it ever was true anywhere.

[stevenf]

Inflating debts away also devalues savings which primarily affects those who need them to live on - the elderly especially.

Inflating debts away has been done but it is not a problem free solution.