Monday, June 13, 2011

The ECB Monetary Policy Mess in One Picture

San Francisco Fed economist Fernanda Nechio shows us in one picture the ECB monetary policy mess:

If there were any doubt that the ECB is in practice narrowly setting monetary policy for the core countries (i.e. Germany and France) this figure should remove it.  The figure should also nix any doubts as to whether what is good for the core is good for the periphery.  ECB monetary policy was too loose in the early-to-mid 2000s and now it is too tight.  If the ECB really wants to preserve the Eurozone in its current form it must confront this reality.  So far it hasn't and this is why I say the ECB is fiddling while the Eurozone is burning.


  1. It would be interesting to see the NGDP growth for those countries.

  2. The countries Nechio includes as "periphery" (Portugal, Ireland, Greece, Spain) total about 16% of Eurozone GDP. This roughly compares to about 13% for California as a percent of U.S. GDP.

    By Nechio's definition, the ECB is setting monetary policy according to the Taylor Rule appropriate for 84% of the Eurozone GDP. Throwing Italy into the Periphery would change that picture somewhat, although I'm not sure that country has as high an output gap as the others.

    Perhaps by population the periphery is more borad. Since the Eurozone is a political construct, the ECB should arguably take this into account.

  3. I disagree not only with your interpretation of the paper but also the paper itself.

    First, if you look at figure one the ECB is setting monetary policy appropriate for the entire euriozone from at least 2005 according to his Taylor Rule. The distance between the core lines and the periphery lines in figure three is appropriate given their relative weights in GDP.

    Second, Taylor's original version of the rule used output gaps not unemployment rates (granted I prefer Rudebusch's). Output gaps are easily found at the IMF. Although Portugal Spain and Greece all have higher unemployment rates than the core nations in his study, Finland, France, Germany and Italy all had larger output gaps than those nations in 2009. The same is true in 2010 with the exception of Germany. And it is estimated all of the countries in the eurozone in his study will have about the same output gap in 2011 (2.5-3%) with the exeption of Germany (-0.5), Belgium (-1.5), Austria (-2.1), Portugal (-4.0) and Spain (-6.4). So only in 2011 to you begin to see a pattern where some of the core nations have smaller output gaps and some of the peripheral nations have larger output gaps than the majority of a plurality of nations in his study.

    The biggest hint there was something wrong was when I looked at his estimate of the unemployment gap for Spain. Spain is not performing much differently with respect to real GDP trend than the core of Europe. Neither is Portugal. Greece only fell behind in 2010 when they failed to rebound. And only has Ireland been a consistent outlier.

    Regardless, in these times, the Taylor Rule is no of much use. It would be better to look at NGDP trend. And by that standard monetary policy is far too tight for the entire eurozone, even Germany.

    P.S. The asymmetry in state performance in the US continues to be much more variable than in Europe. Those thinking the fiscal crisis in the eurozone is the product of an asymmetric shock are wrong with respect to Iberia and neeed to ask why the US is not experiencing similar problems.

  4. "Spain (-6.4)" should read "Ireland (-6.4)". Other than the missing letters and words the meaning is larely the same. I think I need a new keyboard for my desktop.

    Also I'm curious about the estimated unemployment gaps. I thought Spain's NAIRU was above 14% for example. His unemployment gap suggests it's only 12%.

    P.S. And I was looking at real GDP for these 11 nations and noticed only Germany, Belgium and Austria have managed to exceed their previous high after 3 years. Tahat tell's me it's far too tight even for the core.

  5. Mark:

    I believe it was the blogger Kantoos that looked at Germany's NGDP level and it looked fine. Yes, it had collapsed, but it had returned to reasonable trend, one consistent with where it would have been absent the boom period. That being said, then again it points to ECB monetary policy being okay for Germany, but not for the periphery.

  6. David,
    Yes, I recall kantoos' post and I vehemently disagreed with him at the time. And if I recall correctly he grudgingly acknowledged many of my criticisms.

    Incidentally Krugman's latest blog posting echos some of my criticisms...and takes it even further. He points out that Rudebusch's coefficients are estimated from the US and could hardly be applicable to all eurozone members where they have very different and greatly diverse labor institutions.

    Simply put, the Nechio paper is a huge mess.