Bond-buying won’t save the euro-zone

19 September, 2012 at 18:19 | Posted in Economics | Leave a comment

The president of Germany’s Bundesbank – Jens Weidmann – yesterday quoted Goethe’s Faust to make his point on the new bond-buying policy of the European Central Bank. According to Weidmann, the play highlighted “the core problem of today’s paper money-based monetary policy” and the “potentially dangerous correlation of paper money creation, state financing and inflation”.

Financial Times reports:

In early scenes from Goethe’s tragedy, Mephistopheles persuades the heavily indebted Holy Roman Emperor to print paper money – notionally backed by gold that had not yet been mined – to solve an economic crisis, with initially happy results until more and more money is printed and rampant inflation ensues.

While he did not make the comparison from Faust Part Two explicit, for Mr Weidmann there are clearly parallels with the performance of the ECB in trying to save the euro.

Mr Weidmann has said the ECB plan, dubbed outright monetary transactions, or OMT, is “tantamount to financing governments by printing banknotes”.

In Tuesday’s speech in Frankfurt, Goethe’s birthplace,he said: “The state in Faust Part Two is able at first to rid itself of its debts while consumer demand grows strongly and fuels a strong recovery. But this later develops into inflation and the monetary system is destroyed by rapid currency depreciation.”

Mr Weidmann did not directly address ECB policy. But monetary policy independence and policy makers who target price stability were, he said, “necessary, but not sufficient, conditions” to maintain people’s trust in a currency.

The ECB declined to suggest any literary precedents that might be used to make the case in favour of OMT.

Mr Weidmann did not highlight another cautionary tale from the play for economists. Faust in the final earthbound scene comes up with a plan for universal prosperity and happiness … and promptly dies.

The euro-zone is today facing the same kind of financial and economic problems that have trapped Japan for almost three decades. To even for a second believe that the new bond-buying policy of ECB would take the euro countries out of the deep recession that a single currency and concomitant austerity policies have placed these countries in, is a belief without any other foundation than hope itself.

Bond-buying may be good, but it’s certainly not good enough to keep the defenseless uncompetitive periphery countries of the euro-zone from falling deeper in to the pit, since the painful adjustment costs in face of the intermittent asymmetric disturbances that hit the euro-zone will not be much effected.

Lars E. O. Svensson, showed in a recent article – ”The Possible Unemployment Cost of Average Inflation below a Credible Target” – that the Swedish Riksbank during the years 1998-2011 had been pursuing a policy that in reality made inflation on average 0.6 percentage units lower than the goal set by the Riksbank. The Phillips Curve he estimated showed that unemployment as a result of this overly “austere” inflation level had been almost 1% higher than if one had stuck to the set inflation goal of 2%. Not to mention what would have happened to unemployment if the inflation goal had been 3-4% …

What Svensson is saying, without so many words, is that the Swedish Fed for no reason at all has made people unemployed. As a consequence of a faulty monetary policy the unemployment is considerably higher than it would have been if the Swedish Fed had done its job adequately.

And the same goes for the ECB and the euro-zone.

The recovery of the euro-zone – with or without a bond-buying ECB – is still not in sight. As long as ECB is bound to its inflation objective – “below, but close to, 2%” – there can’t be any real hope for solving the economic and financial quagmire that this gobsmackingly stupid price stability goal has put half of Europe in.

Added: And, of course, we shouldn’t forget that the ECB is conditioning its purchasing of government bonds on budget cuts in the peripheral countries. Cuts that will only make it even harder to get out of the euro pit. It’s really a perverse policy since it basically asks these countries to sink even deeper into the austerity pit before  the ECB will try to help them out of it with fresh cash. Unbelievable! And so wrong, so wrong.

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