Friday, December 2, 2011

The Eurozone Crisis is a Monetary Crisis, Not a Fiscal One

So argues Ambrose Evan-Pricthard:
This is a monetary crisis, caused by a jejune central bank that aborted a fragile recovery by raising rates earlier this year, allowed the money supply to collapse at vertiginous rates in southern Europe, and caused a completely unnecessary recession — and a deep one judging by the collapse in the PMI new manufacturing orders in November.
Needless to say, drastic fiscal austerity is making matters a lot worse. You cannot push two-thirds of the eurozone into synchronized fiscal and monetary contraction without consequences.
Another way of saying this is that the ECB allowed nominal spending and thus nominal incomes to drastically fall in the Eurozone--a passive tightening of monetary policy--and this, in turn, made it difficult for European countries to service their debt. As a result, a fiscal crisis has emerged in the Eurozone.  To make matters worse, the fiscal crisis is viewed as the cause of the Eurozone's problems and is therefore being treated with the fiscal solution of austerity.  The fiscal crisis should, instead, be viewed as a symptom of tight money and treated appropriately with monetary easing.

 Here, again, is, Evan-Pritchard:
This crisis can be stopped very easily by monetary policy, working through the old-fashion Fisher-Hawtrey-Friedman method of open-market operations to expand the quantity of money, ideally to keep nominal GDP growth on an even keel. 
What they should be doing is quantitative easing, which is perfectly legal under EU treaty rules and the bank's mandate. Doesn't the ECB's twin pillar doctrine say that M3 money should be growing at 4.5pc? Well it is not doing so. It contracted in October, month-on-month. So get on with it.
The crisis canundoubtedly be halted immediately by the ECB. The bank can reflate Club Med off the reefs. It chooses not to act for political reasons because this mean higher inflation for Germany. That is the dirty secret. Everybody must be crucified to keep German internal inflation under 2pc.
Yes, nominal GDP is crashing in Eurozone's periphery while it is close to trend in Germany.  This is nothing new for Germany which has a history of maintaining stable monetary conditions at home no matter the cost to the rest of the Europe.  The question now is whether Germany values the Eurozone project enough to allow the monetary solution to be implemented.  So far it has not been terribly interested in the monetary solution.


  1. Oh please, spare us Ambrose-Pritchard! He (and to some extent his newspaper too) is representative of a die-hard group of British eurosceptics, and any criticism of the EU from them is to be taken with a bag of salt.

    "Everybody must be crucified to keep German internal inflation under 2%". Rubbish: eurozone inflation is presently about 3% ( ), which suggests that, in the sensible world, wherein the central bank is not the only institution with any influence over real growth, the ECB was justified in hiking in the summer, and is right to be cautious about reckless easing now.

  2. the German GDP will not stay close to trend much longer.
    That plus the deceleration in YoY inflation in the euro area will prompt the ECB to start monetary easing.

  3. Europe wide stimulus might work as suggested by Ambrose EP, but I were German I’d be tempted not to give it a try on the grounds that any such stimulus would just raise inflation in the periphery by as much as it would raise it in Germany, which would defeat the object of the exercise.

    Greeks are not exactly averse to awarding themselves early retirement, wage increases with (in their eyes) no obligation to pay taxes to foot the bill for it all.