Yves here. Note how the need to pretend Deutsche Bank is not undercapitalized, mentioned in passing in this post, is playing into policy.
Q: Despite recent criticism from senior researchers, the IMF refrained from direct criticism of the government over its fiscal policy in its latest annual survey of the UK. Is the political arm of the Fund winning out against the research side?
A: I think that there is a discrepancy between the IMF’s position on Britain and its position on the eurozone. With regards to Britain the research department of the IMF may have been critical of Osborne’s fiscal policy but the political structure of the Fund is such that other than issue some mild warnings they will not confront the government on this.
The primary reason is that even though they think that Osborne is using suboptimal fiscal policy they trust that the Bank of England will do all it takes to ensure that it does not lead to systemic difficulties.
Q: Do you think they are also worried about the charge of hypocrisy if they attack the UK for tight fiscal policy and play their part in maintaining pressure on the peripheral eurozone governments to rein in spending?
A: Not really. On the eurozone the IMF are much more vocal about their discomfort with Troika policy, of which they are part. The IMF understands that the UK doesn’t have a structural problem it has a problem of suboptimal fiscal policy, whereas the eurozone has a deep structural crisis. By this I mean the deadly embrace between the banks and the state.
Even if austerity was its favoured policy elsewhere the IMF understands that it’s simply catastrophic when you have collapsing banking systems without the support of a central bank – particularly in a situation where you have a self-reinforcing feedback loop between the insolvency of the member state and the banks. So the IMF is willing to play tough with Germany over the necessity of a banking union.
If the IMF does adopt a belligerent stance it is likely to be over the need for a banking union. I don’t think they’re prepared to open up another front just yet.
Q: Have we learned from the Cyprus crisis that policymakers are willing to sacrifice the economies of smaller member states when they find themselves in trouble? For example if Cyprus is a template, what does it mean for Greece?
A: There is a strong element of that. What I take out of the way Cyprus was treated is that policymakers will do anything it takes to address a local crisis in the short term without any considerations of the longer term implications of what they are doing.
They are prepared to spend quite a lot of money in order to remain in denial about the systemic nature of the crisis. In the case of Greece, for example, they have spent a huge amount of money failing to fix the situation but what they have succeeded in doing is convince people that it is fundamentally a Greek crisis.
Now they’re expending and pretending the same about Cyprus. But the systemic implications of this are enormous. Raising capital controls within a monetary union is just absurd policy. This is likely to come back to haunt them.
Q: Even at this stage of the eurozone crisis, is there still a possibility of resolving the crisis without a fundamental revision of the founding treaties?
A: Absolutely. We don’t need treaty changes in order to redeploy existing resources to end this crisis in a rational manner. After the crisis is behind us they can discuss any treaty changes they may want, or do not want. The question, therefore, is why are they reluctant to do this?
I think there are two primary reasons:
The first is Deutsche Bank. Germany is not going to take any steps that would make it more likely for rays of light to be shone into the black hole on Deutsche Bank’s balance sheet. They are very worried about that. Any measures that would require Greek banks to be examined more closely are likely to draw more attention to German banks too, so they would prefer to allow the zombification of Greek banks to avoid this.
The second reason is that any steps that can be taken in order to ameliorate the crisis and prompt an investment surge through bodies such as the European Investment Bank will involve tying member states closer together. This would make it very hard for Germany to maintain the option of leaving the eurozone.
It’s not that it wants to get out of the eurozone but it want to maintain the right and the opportunity to do so. This is not in order to exercise that right. Merely having it on the table boosts the bargaining power of the German Chancellor hugely in discussions with European counterparts.
Q: By passing the responsibility for crisis management to the European Central Bank, are eurozone politicians assuming that the structural problems of the monetary union can be overcome by monetary policy alone?
A: Mario Draghi is a smart man and he would never assume that his role is apolitical. Most of the major moves that he has made since taking over as President of the ECB have been discussed with and agreed by eurozone politicians. As is always the case, there is nothing more political than the pretence of being technocratic.
In the case of OMT the markets have a common perception that, if circumstances required it, Draghi will violate his own rules and unleash the programme without the conditions for its use being fulfilled. As long as markets believe there’s a significant probability of that they will not test the ECB, at least for the moment.
So although it would not be my preferred option there is an argument that the periphery could collectively request access to OMT, which would then operate like QE in the US and UK. However, the existence of a collective interest does not translate automatically to collective action. One of the greatest problems for Europe is how to turn the one into the other.
Q: We are seeing signs of a tentative pick-up in the US and overall the global economy is ticking along close to its long run average growth level. Is it possible that the eurozone could grow its way out of its current difficulties?
A: I have been saying for a number of years now that monetary policy, even if it is properly coordinated, is utterly incapable of translating surpluses into investments. It can be very helpful in steadying markets and re-inflating bubbles but it cannot push that into investments on a scale that it large enough to ameliorate the loss of aggregate demand worldwide.
It’s clear that European leaders are pinning all their hopes on a global recovery lifting them up, but I don’t think that’s really possible. I think they will be seriously disappointed.