Jeffrey Frankel, a Project Syndicate columnist and professor at Harvard University’s Kennedy School of Government says the ECB Should Buy US Treasuries.
The European Central Bank needs to ease monetary policy further. Eurozone-wide inflation, at 0.8%, is below the target of “close to 2%,” and unemployment in most countries remains high. Under current conditions, it is hard for the periphery countries to reduce their costs to internationally competitive levels, as they need to do. If inflation in the eurozone as a whole is below 1%, the periphery countries are condemned to suffer painful deflation.
That paragraph alone makes it easy to see that Frankel is in academic wonderland. Europe could actually use falling prices. So could every other country on the planet. Ask any consumer if they want falling prices and the result would be close to unanimous.
As I have pointed out on numerous occasions, the idea that falling prices stop people from buying goods is as idiotic as it is well entrenched.
The question is how the ECB can ease policy, given that short-term interest rates are already close to zero. Most of the talk in Europe concerns proposals to undertake quantitative easing (QE), following the path taken by the US Federal Reserve and the Bank of Japan.
But QE would present a problem for the ECB that the Fed and other central banks do not face. The eurozone has no centrally issued and traded Eurobond that the central bank could buy. (And the time to create such a bond has not yet come.) By purchasing bonds of member countries, the ECB would be taking implicit positions on their individual creditworthiness.
The German Constitutional Court believes that the OMT scheme exceeds the ECB’s mandate, though it has temporarily tossed that political hot potato to the European Court of Justice.
The legal obstacle is not merely an inconvenience; it also represents a valid economic concern about the moral hazard that ECB bailouts present for members’ fiscal policies in the long term. That moral hazard – a subsidy for fiscal irresponsibility – was among the origins of the Greek crisis in the first place.
What, then, should the ECB buy if it is to expand the monetary base? For several reasons, it should buy US treasury securities. In other words, it should go back to intervening in the foreign-exchange market.
For starters, there would be no legal obstacles. Operations in the foreign-exchange market are well within the ECB’s remit. Moreover, they do not pose moral-hazard issues (unless one thinks of the long-term moral hazard that the “exorbitant privilege” of printing the world’s international currency creates for US fiscal policy). Finally, ECB purchases of dollars would help push down the euro’s exchange rate against the dollar.
From there, Frankel jumps straight into the economic loony bin.
In this case we are talking about an ECB purchase of dollars that would change the euro money supply. The increase in the supply of euros would naturally lower their price. Monetary expansion that depreciates the currency is more effective than monetary expansion that does not, especially when, as is the case now, there is very little scope for pushing short-term interest rates much lower.
Monetary expansion by definition depreciates currency and distorts pricing mechanisms. Frankel continues …
Depreciation of the euro would be the best medicine for restoring international price competitiveness to the periphery countries and reviving their export sectors.
Once again Frankel proves he does not understand the forces in play. The major problem in the periphery is lack of competitiveness with Germany and the Northern Eurozone countries. Affecting the exchange rate of the euro itself does nothing to correct those imbalances.
If abandoning the euro is not the answer, depreciation by the entire eurozone is.
Frankel keeps digging bigger and bigger holes.
Out of the blue he makes a statement akin to “If fishing is not the answer, then sending a spaceship to pluto is.”
What if “fishing” is the answer?
In context, abandoning the euro is precisely the answer because that is the fastest way for the periphery to shed debt and regain competitiveness with Germany.
By now, readers can easily see the “Law of Bad Ideas” in play, specifically Corollary Number Four: The worse the idea, the more likely it is to be embraced by academia and political opportunists.
For a thorough rebuttal to the absurd notion that deflation is a bad thing, please see Monetarism, Abenomics, QE, and Minimum Wage Proposals: One Bad Idea Leads to Another, and Another.
Mike “Mish” Shedlock