Saturday, July 28, 2012

ECB's Means (Lost Decade With High Unemployment) To An End (Structural Reform)

Early in the week, global stock markets were falling fast as Spanish yields surged higher across the curve. Fearing that markets would quickly spiral out of hand, Jon Hilsenrath (WSJ) stemmed the tide by signaling forthcoming action from the Federal Reserve next week. Not to be outdone by his US counterpart, the ECB’s Mario Draghi provided a bazooka of open mouth operations by stating:
"The ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough"
As Bruce Krasting points out, this is not the first time an EU politician has proclaimed an end to the crisis. While details of Draghi’s plan remain largely unknown (and undecided?), even his best efforts will do little to spur economic growth. Spain is suffering from excessive private debt, a bursting housing bubble and as Krasting notes:
its competitiveness. The domestic economy will never recover without a currency devaluation (and debt restructuring). If Mario has his way, Spain will suffer from a decade of recessions with unemployment over 20%.  How could he possibly call that outcome a success?
The answer to that question is actually quite simple and was given by JW Mason in a post titled Pain Is the Agenda: The Method in the ECB's Madness:
Here's an editorial in the FT on the occasion of last summer's ECB intervention to support the market for Italy's public debt:
Structural reform is the quid pro quo for the European Central Bank’s purchases last week of Italian government bonds, an action that bought Italy breathing space by driving down yields. ... As the government belatedly recognises, boosting Italy’s growth prospects requires a liberalisation of rigid labour markets and a bracing dose of competition in the economy’s sheltered service sectors. This is where the unions and professional bodies must play their part. Susanna Camusso, leader of the CGIL, Italy’s biggest trade union, is threatening to call a general strike to block the proposed labour law reforms. She would be better advised to co-operate with the government and employers... The government’s austerity measures are sure to curtail economic growth in the short run. Only if long overdue structural reforms take root will the pain be worthwhile.
A couple of things worth noting here. First the explicit language of the quid pro quo -- the ECB was not just doing what was needed to stabilize the Italian bond market, but offering stabilization as a bargaining chip in order to achieve its other goals. If ECB was selling expansionary policy last year, why be surprised they're not giving it away for free today? Note also the suggestion that a sacrifice of short-term output is potentially worthwhile -- this isn't some flimflam about expansionary austerity, but an acknowledgement that expansion is being give up to achieve some other goal. And third, that other goal: Everything mentioned is labor market reform, it's all about concessions by labor (including professionals). No mention of more efficient public services, better regulation of the financial system, or anything like that.
The FT editorialist is accurately presenting the ECB's view. My old teacher Jerry Epstein has a good summary at TripleCrisis of the conditions for intervention; among other things, the ECB demanded "full liberalisation of local public services…. particularly… the provision of local services through large scale privatizations”; "reform [of] the collective wage bargaining system ... to tailor wages and working conditions to firms’ specific needs...”;  "thorough review of the rules regulating the hiring and dismissal of employees”; and cuts to private as well as public pensions, "making more stringent the eligibility criteria for seniority pensions" and raising the retirement age of women in the private sector. Privatization, weaker unions, more employer control over hiring and firing, skimpier pensions. This is well beyond what we normally think of as the remit of a central bank.
So what Krugman presents as a vague, speculative story about the ECB's motives -- that they want to hold politicians' feet to the fire -- is, on the contrary, exactly what they say they are doing.
It's true that the conditions imposed by the ECB on Italy and Greece were in the context of programs relating specifically to those countries' public debt, while here we are talking about a rate cut. But there's no fundamental difference -- cutting rates and buying bonds are two ways of describing the same basic policy. If there's conditions for one, we should expect conditions for the other, and in fact we find the same "quid pro quo" language is being used now as then.
Here's a banker in the FT:
The future of Europe will therefore be determined by the interests of the ECB. Self-preservation suggests that it will prevent complete collapse. If necessary, it will overrule Germany to do this, as the longer-term refinancing operations and government bond purchase programme suggest. But self-preservation and preventing collapse do not amount to genuine cyclical relief and policy stimulus. Indeed, the ECB appears to believe that in addition to price stability it has a mandate to impose structural reform. To this extent, cyclical pain is part of its agenda.
Again, there's nothing irrational about this. If you really believe that structural reform is vital, and that democratic governments won't carry it out except under the pressure of a crisis, then what would be irrational would be to relieve the crisis before the reforms are carried out. In this context, an "irrational" moralism can be an advantage. While one can take a hard line in negotiations and still be ready to blink if the costs of non-agreement get too high, it's best if the other side believes that you'll blow it all up if you don't get what you want.  Fiat justitia et pereat mundus, says Martin Wolf, is a dangerous motto. Yes; but it's a strong negotiating position.  
The whole post is well-worth reading, but these comments say it all. By working to prevent an all out collapse of the EMU, Draghi is merely taking the necessary actions to maintain his position. If Spain or other European countries must “suffer from a decade of recessions with unemployment over 20%” in order to implement the desired structural reforms than so be it. Whether or not that outcome is politically feasible remains an open question, but I have my doubts. Draghi was not the first to claim “it will be enough" and won’t be the last to make that claim either.


  1. woj,
    They say expectations matter, right? Draghi's announcement seems to have had a positive effect in this regard, albeit very short term. We've seen this movie before. It's only a matter of time before people that matter stop paying attention to false expectation pronouncements.
    Nick Rowe had a very interesting post yesterday on ending the EU. The money quote was rather amusing: "The PIIGS are all pregnant, and Germany is the father."

    1. "It's only a matter of time before people that matter stop paying attention to false expectation pronouncements."
      Although I don't disagree, one would have thought that time would already be here after three years of watching the same movie play out time and time again. While politicians/central bankers hold the ability to end the crisis, the point of this post was to show that their interests do not necessarily align with the public's optimistic expectations.

  2. woj,
    I couldn't agree more. I can't believe this movie keeps being re-run and people still expect different results. What was that line by Einstein about doing the same thing over and over and expecting different results?
    I left you a reply over at Mike's Diary of a Republican.... on this thread: