In yesterday's blog post Paul Krugman summarizes very well the position of some academic economists who deny the potential role that aggregate demand might have in explaining business cycles and, as a result, they reject any policies that might have an effect via the demand channel. Their models are only driven by changes in the productive capacity of an economy which means that the Great Recession (or the Great Depression) must have been the result of some destruction in our capital stock or our inability to remember how to work or produce or somehow our technology got worst than in previous years.
It might be that these economists are just describing an ideal world using assumptions that are very far from the real world but how is it possible that these ideas seem to have such a strong influence in economic policy and even support among the general public? Why is it that countercyclical policy (fiscal or monetary) has been challenged so much during the current crisis? Most policy makers and certainly the public at large do not share the assumptions used by those economic models. In fact, when most people are asked to describe the dynamics of economic crisis, they immediately refer to some notion that shortages of demand cause recessions. When I teach about recessions and I ask my students about the cause of business cycles they immediately tell a story that sounds like the very basic keynesian multiplier (spending reduces income which further reduces spending...). But when the same students are asked to give their views about appropriate economic policies during a crisis, they immediately show their distrust in governments and central banks in their ability to help smooth business cycles. Somehow, expansionary fiscal policy or monetary policy cannot work because it is driven by the government.
So we end up with an odd coalition of views against countercyclical economic policy: those who rely on models where by definition countercyclical policy is ruled out and those who do not believe in these models (they laugh at them if you explain all the assumptions) but because they have no trust in governments they end up reaching the same conclusion.
Sunday, January 12, 2014
Wednesday, January 8, 2014
The increasing number of Euro fools.
Via the Irish Economy Blog I find this very interesting interview of Mario Draghi with Der Spiegel. I was first surprised by the aggressive responses from Draghi every time he is asked about the German negative assessment of recent ECB monetary policy. I like his honesty and clarity when he asserts that all German fears about increasing inflation in the Euro area have turned to be wrong. Here is one of his answers:
"DRAGHI: No, but the fears felt by some sectors of the public in Germany have not been confirmed. What haven’t we been accused of? When we offered European banks additional liquidity two years ago, it was said there would be a high rate of inflation. Nothing has happened. When I made my comment in London, there was talk of a violation of the central bank’s mandate. But we had made clear from the beginning that we are moving within our mandate. Each time it was said, for goodness’ sake, this Italian is ruining Germany. There was this perverse Angst that things were turning bad, but the opposite has happened: inflation is low and uncertainty reduced."
Of course, the journalist is not convinced and continues asking questions about the potential damage that ECB policies are inflicting in Germany. He follows with a set of questions on how the low interest rate policy of the ECB is hurting savers in Germany. Here is the first one:
"SPIEGEL: In Germany, ECB policy is unpopular because you have now pushed the interest rates for investments down so far that they are often no longer enough to compensate for inflation. In other words, only fools save."
This question reflects a really poor level of understanding of some basic economic principles. The statement "only fools save" can only be consistent with the data if the number of fools has increased dramatically in recent years. Interest rates are low because saving is high (and investment is low). Not the other way around.
And here is the next one:
"SPIEGEL: People can see in the statements from their life insurance companies that they are getting ever smaller payouts from year to year because of the interest rates. The truth is that savers are paying the price for rescuing the euro."
Savers are paying the price of fear and a long-lasting crisis. Both have reduced spending and as a result the equilibrium (real) interest rate. And more so in countries that are perceived as safe (as in the case of Germany).
Draghi is good at responding to both of these questions but I find his tone less aggressive than when he answers the questions on inflation. Maybe central bankers need to be more explicit about their (limited) influence on interest rates. The (wrong) perception among many is that interest rates, both nominal and real, for all maturities and risk profiles are determined by central bank policies.
Antonio Fatás
"DRAGHI: No, but the fears felt by some sectors of the public in Germany have not been confirmed. What haven’t we been accused of? When we offered European banks additional liquidity two years ago, it was said there would be a high rate of inflation. Nothing has happened. When I made my comment in London, there was talk of a violation of the central bank’s mandate. But we had made clear from the beginning that we are moving within our mandate. Each time it was said, for goodness’ sake, this Italian is ruining Germany. There was this perverse Angst that things were turning bad, but the opposite has happened: inflation is low and uncertainty reduced."
Of course, the journalist is not convinced and continues asking questions about the potential damage that ECB policies are inflicting in Germany. He follows with a set of questions on how the low interest rate policy of the ECB is hurting savers in Germany. Here is the first one:
"SPIEGEL: In Germany, ECB policy is unpopular because you have now pushed the interest rates for investments down so far that they are often no longer enough to compensate for inflation. In other words, only fools save."
This question reflects a really poor level of understanding of some basic economic principles. The statement "only fools save" can only be consistent with the data if the number of fools has increased dramatically in recent years. Interest rates are low because saving is high (and investment is low). Not the other way around.
And here is the next one:
"SPIEGEL: People can see in the statements from their life insurance companies that they are getting ever smaller payouts from year to year because of the interest rates. The truth is that savers are paying the price for rescuing the euro."
Savers are paying the price of fear and a long-lasting crisis. Both have reduced spending and as a result the equilibrium (real) interest rate. And more so in countries that are perceived as safe (as in the case of Germany).
Draghi is good at responding to both of these questions but I find his tone less aggressive than when he answers the questions on inflation. Maybe central bankers need to be more explicit about their (limited) influence on interest rates. The (wrong) perception among many is that interest rates, both nominal and real, for all maturities and risk profiles are determined by central bank policies.
Antonio Fatás
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