Is the ECB really so generous?

A simplified, to the point of being simplistic, approach to understanding the transmission of monetary policy to the real economy consists of three basic links:

1. The central bank fixes, or at least strongly influences, the marginal cost of bank funding through its interest rates;
2. Banks equalise the expected marginal cost of their own funding to the marginal revenue from lending;
3. Firms, households and the external sector, in the latter case through the exchange rate, increase or decrease aggregate demand, and ultimately prices, in line with the cost of bank lending.

Titus Maccius Plautus and the EU Troika

The Roman comic playwright Titus Maccius Plautus takes up an old adage of Greek origin when he writes in his Bacchides: "Quem di diligent, adolescens moritur", which translated into English sounds: "Whom the gods love die young". This is of course a paradox: the empirical proof that gods do not make a favour to those they love by making them die young is the fact that large shares of national income are devoted to maintaining or regaining health, in view of a long life. But, taking the same paradoxical line as Plautus, I am tempted to say: "Happy the countries that had the troika!"

Some unpleasant Quantitative Easing Arithmetic

Some 30 years ago Thomas Sargent and Neil Wallace published an article [1] that raised the possibility of tight monetary policy leading to inflation. Salvatore Rossi and I showed that this result was due to a questionably formulated public budget constraint in their model [2] and basically salvaged the traditional result that it is loose monetary policy that leads to inflation.

The link between that old story and Quantitative Easing is that there is something unpleasant about Quantitative Easing arithmetic, at least for those market observers that, with some justification, interpret recent ECB message as pre-announcement of some exercise of this sort.

Is the €-area in 2014 like Japan on the dawn of deflation?

If you are impatient and somewhat trust my judgment, let me give first my synthetic answer to the title question: out of the five criteria I use to compare the current situation in the €-area to that in Japan at the end of the ´90s, two (current situation of the banking sector and inflationary expectations) do not indicate that the €-area is in a better position than Japan when it was about to enter its deflationary period. On one other criterion (central bank activism) there is a slight advantage for the ECB. On the two last criteria (the prospective cleaning up of the banking sector and demography) the situation in the € area is clearly better than it was in Japan. Overall, my sense is that, in particular taking into account the recent hesitations of the ECB to confront too low inflation, confirmed in the last press conference, and the now weakly anchoring of inflationary expectations, one cannot exclude a significant risk of Japanification for the €-area.

Partiam, partiamo or the ECB communication

In the "Atto secondo, Scena IV" of Verdi`s opera, La Forza del Destino, there is a famous choir which keeps singing "partiam, partiam, partiamo" (let's leave, let's leave, let's leave) while remaining stubbornly on the scene, without making deeds follow words.

I cannot help recalling this scene while observing the communication from the ECB.

It is a few months, since November of last year when it last reduced rates, that the ECB is sending the message that it is ready to reinforce its action to symmetrically pursue its objective of "close but lower than 2.0% percent in the medium term", while not actually following up with action.

From firmly to weakly anchored, or the importance of an adverb!

Four months ago I published a post with the title: Is the price stability target of the ECB at risk? In it I explored the risk of inflation remaining too low for too long in the €-area.

My conclusion was: ”yes, there is a risk for the price stability objective, but the probability of this unfavourable development is low if the ECB will use its tools appropriately.” In light of the lack of action by the ECB in March, even when projecting inflation remaining well below its objective of “close but below 2.0% in the medium run” for the fourth year, it is useful to review the issue and update the answer.

Macro-prudential: if not now when?

At the turn of 2000, when the € was at 0.85, very weak, against the dollar, the then Economic Counselor of the International Monetary Fund, Michael Mussa, issued a statement that made some waves in the monetary world: "if not now when?" [1]. With that statement he made the point that if there was a time when a central bank had to resort to the unusual step of intervening in the foreign exchange market, that time had arrived for the European Central Bank.

Galileo Galilei and the €-crisis

Just a few days it ago was the 450th anniversary of the birth of Galileo Galilei and this suggested me a comparison with the €-crisis.

Legend says that when Galileo Galilei exited, on the 22nd of June of 1633, from Santa Maria sopra Minerva, in Rome, where the Catholic church held a process against him, he pronounced the famous sentence: “And yet, it moves”, referring to the fact that, contrary to the view of the then majority of people, it was the earth that moves around the sun and not the opposite.  Since that day, the case of Galileo Galilei has become the archetypal case to demonstrate that the majority, even when supported by a strong institution such as the catholic church, is not always necessarily right.

When will it be "1989" in China?

Many market commentators are trying to assess whether China will manage to fully implement the decisions of the Third Plenary Session of the 18th Communist Party of China Central Committee, held from 9th to 12th of November 2013. The top of the Communist Party seems to be convinced that, as former Premier Wen Jiabao said, the Chinese economy is fundamentally unbalanced and needs a significant redirection [1].

Emerging Market turmoil and the canary in the coal mine

There was a time when developments in Emerging Markets (EM) mattered a lot for them, but much less for the rest of the world, as they were too small and too isolated to really influence the global economy. These days are long gone: Chart 1 shows that in the eighties the share of EM in the global economy was still only a half of that of Developed Markets (DM), now the EM are slightly bigger than the DM economies in aggregate terms and the trend is forecast to continue.