One of the great mistakes among economists is to receive the measures of central banks as if they were revealed truth. It’s surprising and concerning that it’s considered mandatory to defend each of the actions of central banks.
That is, of course, in public. In private, many colleagues shake their heads in disbelief at the accumulation of bubbles and imbalances. And, as on so many occasions, the lack of constructive criticism leads to institutional complacency and a chain of errors that all citizens later regret.
Monetary policy in Europe has gone from being a tool to help states make structural reforms to becoming an excuse not to carry them out.
The steady funding of the deficits of countries that perpetuate structural imbalances hasn’t helped strengthen growth, as the eurozone has already seen constant GDP estimate cuts before the COVID-19 crisis, but it’s covering up the extreme left populists who defend massive money printing and Modern Monetary Theory (MMT), threatening the progress and growth of the eurozone. Populism isn’t fought by whitewashing over it, and the medium- and long-term impact on the euro area of this misguided policy is unquestionably negative.
Today, citizens are being told by numerous European extreme left politicians that structural reforms and budgetary prudence are things that were implemented by evil politicians with malicious intent, and the message that there’s unlimited money for anything, whenever and however, is supported by the central bank actions.
It’s surprising to hear some serious economists at the European Central Bank (ECB) or the Federal Reserve say that they don’t understand how the idea that money can be printed eternally without risk is so prevalent in the political debate when it’s the central banks themselves that are providing that false sense of security. The central bank may disguise risk for a time but doesn’t eliminate it.
Greece, Cyprus, Lithuania, Slovakia, Spain, Portugal, and Slovenia are already borrowing at negative real rates. However, negative rates aren’t a sign of confidence in government policies, but an aberration of monetary policy that hides the real risk. And sooner or later, it bursts.
When politicians say that negative yields reflect the confidence of markets in the country, it’s simply lying. The ECB is on its way to owning 70 percent of outstanding sovereign debt in the eurozone, and it buys all the net issuances after redemptions, according to Pictet and the Financial Times. There’s no market.
This temporary confidence in the capacity of the ECB to alter risk is only sustained if the euro area grows its trade surplus and its economic output, but mostly if Germany continues to finance it. It isn’t eternal, it isn’t unlimited, and it definitely isn’t without risk.
Many readers will say that this is an exceptional policy due to the COVID-19 crisis, which requires exceptional measures. There’s only one problem with that argument: It’s false.
The ECB’s policy has been ultra-expansive for more than 10 years, in crisis, recovery, growth, and stabilization periods. Interest rates were cut to negative and asset purchases extended in growth and stable periods when there were no liquidity risks in the economy.
In fact, the ECB has become hostage to states that don’t want to reduce their structural imbalances but aim to perpetuate them because the cost of debt is low, and the ECB “supports” them. The ECB should be worried about the fact that the most radical parties, many aligned with the economic policies of Argentina and Venezuela, such as Podemos or Syriza, cheer this monetary insanity as a validation of their theories.
It’s no coincidence that the reformist momentum in the eurozone has stopped abruptly since 2014. It coincides exactly with the massive liquidity injections. Structural reforms and budget prudence are perceived as evil policies. Low rates and high liquidity have never been an incentive to reduce imbalances, but rather a clear incentive to increase debt.
Inflation
The worst excuse of all is that “there’s no inflation.” It’s like driving a car at 300 miles an hour on the highway, looking in the rear-view mirror and saying, “We haven’t killed ourselves yet. Accelerate.”It isn’t a surprise that the eurozone has witnessed a rising number of protests against the increase in the cost of living while the central bank tells us that “there’s no inflation.” But it’s also, at least, unwise to say that there’s no inflation without considering the financial assets that have soared due to this policy.
Insolvent countries with negative-yielding 10-year sovereign bonds is huge inflation. Rising prices for non-replicable goods and services, which in many cases triple the official inflation rate, is huge inflation. Large increases in rent and housing aren’t adequately reflected in official inflation. It’s especially worrying when monetary policy encourages unproductive spending and perpetuates overcapacity. This means lower productivity growth, which means lower real wages in the future.
Take, for example, the eurozone CPI for November. The inflation figure is –0.3 percent. There’s no inflation, right? However, in the same data, fresh food rose 4.3 percent and services 0.6 percent, and the energy component fell 8.3 percent, yet no European citizen has seen a drop of 8.3 percent in their energy bill because neither gasoline nor natural gas or electricity costs, including taxes, have fallen so much.
In fact, if we analyze the cost of living using the goods and services that we really use frequently, we realize that in an unprecedented crisis such as that of 2020, prices for the middle class and the poorest rise much faster than the CPI shows, and that, added to the distorting factor of the enormous inflation in financial assets, generates enormous social problems.
When the ECB ignores demographic trends (longevity reduces inflationary pressures), the effect of overcapacity, and technology, and launches trillions of euros that inflate financial assets and public debt, accumulated risks are much greater than the supposed benefits that the policy can generate.
What to Do
1. Focusing the measures on concrete results and data and, thus, delimiting the action is key to mitigating—albeit not eliminating—perverse incentives. There’s a huge difference between criticizing central banks for everything at any cost without control and saying that they should do nothing.2. Additionally, the central bank must give clear and definitive guidelines on the timing and maximum size of measures. We saw one of the most dangerous perverse incentives in 2018 when, faced with the possibility of a moderate normalization of monetary policy, states and investors forced the hand of central banks to continue with massive injections. In less than two months, central banks changed their policy by 180 degrees.
3. The role of the central bank isn’t to combat climate change or justify unsustainable budgets. It’s to function as a guarantee of liquidity, not a guarantee of low cost, much less a guarantor of first resort. It’s terrifying that European states that already issued bonds at negative real rates before the crisis would collapse due to a meager increase in the cost of debt of 0.5 percent. It shows the severity of the bubble created.
4. The role of the central bank isn’t to bail out investors and governments that play “the worse, the better” strategies, buying the riskiest assets or spending uncontrollably, assuming that monetary policy is going to bail them out forever. It should be to prevent these leveraged bets to spend without control and buy garbage from being generated or, at least, not incentivized.
5. The role of the central bank isn’t to copy the imbalances of others. The ECB isn’t the Federal Reserve, nor is the euro the world’s reserve currency. The ECB’s balance sheet already weighs 61 percent of the eurozone’s GDP, while that of the Fed only 34 percent. Policymakers can’t play dangerously with the credibility of the eurozone in the long term just because in the short term “nothing happens” according to them, especially when it does.
6. Supporting the recovery isn’t supporting structural imbalances, much less unproductive political spending. The objective of a central bank isn’t for states to finance any expenditure at artificially low rates. It compromises the central bank independence and generates enormous negative effects on citizens in the medium term, by eroding real wages and productivity.
7. Something that doesn’t work well in growth periods isn’t failing because of not doing more of it. The surplus liquidity at the ECB is more than 3.4 trillion euros. It was already more than 2 billion in a growth period. If monetary policy hasn’t worked, it isn’t because it’s a problem of injecting more liquidity, when there’s clearly an excess, but because of solvency. And that isn’t solved with a policy that encourages debt, penalizes prudent savings, and perpetuates zombification problems with artificially low rates. It’s no coincidence that the percentage of zombie companies has skyrocketed in times of growth with negative rates.
8. A monetary policy that generates bubbles and financial risk isn’t solved with the same insane policy but is destroying the purchasing power of the currency. If monetary policy hasn’t worked, it isn’t because MMT-style Venezuelan or Argentine “money for the people” policies haven’t been implemented, but because productive investment and sustainable growth come from savings and prudence with risk, not from runaway spending and debt. A problem of perverse incentives isn’t solved with one of greater destruction and impoverishment.
The fact that, for now, enormous risks aren’t perceived—or not perceived by the central bank managers—doesn’t mean that they’re not building. Negative-yielding debt, which has reached a record $18 trillion globally, led by the eurozone and Japan, isn’t a sign of confidence, but rather a huge risk of secular stagnation.
When the central bank leaders argue that they only offer a tool but at the same time they give fiscal and budgetary policy recommendations encouraging states “not to fear debt” and spending much more, not only does the central bank lose independence in the medium term, but also it’s the same as a waiter who doesn’t stop serving you drinks, encourages you to binge, and then blames you for being drunk.
Introducing these huge imbalances has significant risks, and they’re not a speculation about the future. They’re realities today: a huge disconnect between financial assets and the real economy, insolvent states financing themselves at negative rates, bubbles in housing and infrastructure assets, debt from zombie companies or junk debt with historical-low yields, an aggressive increase in leveraged investments in high-risk sectors, perpetuation of overcapacity, etc. Ignoring all these factors in a monetary institution is more than dangerous, it’s irresponsible.
It isn’t time to do everything at any cost whatever happens. It’s time to defend sound monetary policy, or the credibility of institutions will sink even further as the mainstream consensus sings the “Hallelujah Chorus” while the building collapses.
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