By Yanis Varoufakis, a professor of economics at the University of Athens. Cross posted from his website. From an interview for Jornal de Negócios by Jorge N. Rodrigues
Europe is in the clasp of the deflationary forces that resulted directly from its inane handling of the Eurozone crisis. In this interview, I discuss deflation and low-flation and suggest a particular form of quantitative easing that, unlike the Fed’s of the Bank of England’s QE, will not reinflate the bubbles of the financial sector but, instead, will help recycle idle savings into productive investments in Europe’s real economy.
1. Is a deflationary spiral a true risk for the Eurozone (IMF-WEO referred to a 20% probability until end of 2014)? Or would it be correct to say that we are in a state of low-flation mainly due to temporary ‘imported disinflation’?
The Eurozone is already in the clasp of powerful deflationary forces. In the Periphery, the debt-deflationary cycle remains in full swing. If GDP seems to be stabilising (e.g. Greece), or even recovering slightly (e.g. Spain), this is due to the statisticians (correctly) anticipating price deflation. These deflationary expectations mean that a further reduction in nominal GDP ‘translates’ into an anticipated… increase in real GDP (or GDP at constant prices) as long as prices fall faster than nominal GDP. This is why the statisticians are predicting ‘recovery’: Recovery in real GDP terms which, in reality, is a drop in nominal GDP that appears like recovery due to…deflation.
Turning to core, surplus Eurozone countries, ‘low-flation’ is produced endogenously, rather than being imported. To see that this is so, just decompose the GDP of the Netherlands, Finland and Germany. One look at the decomposed data confirms that these economies are suffering from weak internal aggregate demand, which is then reinforced by the reduction in the prices of their goods and services both in the European Periphery and beyond.
Faced with this ominous situation, Europe’s authorities are, once more, interested in one thing only: how to hide the problem under the carpet. For example, the European Banking Authority just announced that the forthcoming stress tests (to be conducted by the European Central Bank) will be based on a number of adverse scenaria not including, however, the threat of deflation. Reuters quoted an analyst suggesting that including a deflationary scenario would be bad for morale because of the devastating impact it would have on public and private sector balance sheets. So, in its infinite wisdom, Europe is adopting the ostrich strategy, burying its head in the sand (assuming that deflation will just go away) and offering inane excuses about the deflationary forces observed as we speak.
One such excuse is that deflation and low-flation is due to the strong euro, and can thus be attributed to ‘imported disinflation’. It is an absurd excuse since the euro’s strength is the direct result of the expanding Eurozone-wide current account surplus which, in turn, is due to Europe’s commitment to austerian fiscal policies at a time when savings exceed investment by a wide margin. While the maintenance of a tight monetary policy, by an ECB unable or unwilling to act, is part of the problem, the main cause of the deflationary phenomenon is Europe’s response to the crisis: the mix of universal austerity and huge loans to insolvent states and banks.
In short, Europe, and the Eurozone in particular, are buffeted by deflationary forces which are the direct result of the particular policy mix that emanates from Berlin and which the other governments have consented to. Now that it is impossible to deny it, Europe’s top echelons are blaming it on the rest of the world, like children caught doing naughty deeds.
2. Is deflation in peripheral Eurozone countries under ‘internal devaluation’ processes necessary? Will it have an impact on the overall eurozone?
In our monetary union, the lack of
• a substantial mechanism for recycling surpluses during a crisis from the surplus regions or states to the deficit ones, and
• a mechanism for deep debt restructuring,
ensure that, after the crisis, the burden of adjustment falls on the regions or states that are least able to withstand it. The result is wholesale depression in these regions or states which, inescapably, reduces aggregate demand in the surplus regions or states, unleashing deflationary forces throughout the monetary union. This is what happened after 1929 to the countries participating in the Gold Standard and it is what is happening in the Eurozone, whose monetary and economic union is a throwback to that Gold Standard.
3. Are historical memories of deflation during the Great Depression, and in Japan in more recent decades, benchmark examples that call for bold monetary action in the Eurozone?
We should have learnt our lessons years ago. The very design of the Eurozone was based on the Gold Standard model. Before the crisis, it encouraged a frenzy of capital flows from the surplus to the deficit countries, which created the bubbles in Spain, Ireland, Greece etc., which then burst causing the crisis. The crisis then led to a vicious reversal of capital flows (from the deficit to the surplus countries), which engendered depression in the Periphery and a deflationary posture throughout the Eurozone. This is what happened after 1929 in the Gold Standard and it is what also happened in the Eurozone after 2008. One wonders why European officials expected anything else, given that they had designed the Eurozone in the image of the Gold Standard. One also wonders why, for six years now, they sit idly by, watching this disaster unfold with the ECB doing virtually nothing.
4. Might all this talk of deflation be a way to press the ECB into larger liquidity injections in favor of European core banks and indirectly to Eurozone sovereign bond purchases, particularly peripheral ones? Could this be part of a strategy to create new bubbles in other financial markets?
Possibly. But, this should not be what we are pressing the ECB to do. The problem is not one of liquidity. And the solution should not be new bubbles.
The ECB did provide massive liquidity to the banks, e.g. under the LTRO, and that did nothing to help, except to buy some extra time for policy makers to get their act together (which they never did!). The aim now should not be to reflate the toxic bubbles by means of quantitative easing, either in the Periphery or in the core countries. The idea discussed currently in Frankfurt, of helping expand the structured derivatives market (bundling SME loans from the Periphery in these derivatives) and then have the ECB buy these ‘products’, is utterly absurd, unproductive and downright dangerous. We need a simple, logical, effective and, yes, virtuous form of quantitative easing. Here is an idea:
The European Council could authorise the European Investment Bank and the European Investment Fund to embark upon a large investment-led recovery program for the whole of the Eurozone, to the tune of 8% of Eurozone GDP. This can be fully financed by net bonds issues by the European Investment Bank, waiving the stipulation of matching funds from the member-states (national contributions). Instead, so as to ensure that the value of these bonds remains high (and their yields low), the ECB could immediately begin a large purchase program of these EIB bonds in the secondary market, to a tune necessary to keep their prices above a certain level. This way, the ECB’s quantitative easing will support proper investments directly into Europe’s real economy and will not have to deal with the problem (that is currently baffling the ECB council’s members) of which bonds or loans (and their nationality) to buy. EIB bonds are triple-A eurobonds (i.e. bonds issued on behalf of the whole of Europe) and, therefore, eminently acceptable paper assets for Europe’s central bank to buy.
5. What are the probabilities that the ECB will move ahead in the next May 8 meeting?
Yanis has proposed an elegant solution. A question I have is whether those who support the current EZ structure of an artificial gold standard and universal austerity would now be willing to adopt such a proposal?
There are europarlament elections soon. If europeans would manage to send a bold message of the kind “act now or you will be fired”, there could be some motivation to act.
A European finance institution (EIB) issues bonds to fund ‘investment’ and another European institution (ECB) buys those bonds to keep the price high (yield low). I am finding it problematic when de-facto ‘money printing’/manipulation is used to solve, what appears to be, at least to me, a collapse in demand and structural problems which politicians have no stomach for addressing.
We can see in China that ‘investment’ is a huge rush into overcapacity and unproductive assets, so on what would this ‘investment’ be spent? No doubt political boondoggles or insider scams to make a few very rich whilst the masses struggle on.
How about the normalisation of interest rates so savers get a return (which they will likely spend so increasing real demand) and investments which need a productive return to finance the borrowing (rather than rolling the ever increasing debt)?
Chances of that happening?
Less than “depressingly low”.
“How about the normalisation of interest rates so savers get a return (which they will likely spend so increasing real demand)”.
I don’t think ZIRP is the solution, but this claim seems a bit optimistic to me.
“seems optimistic to me”
I think unrealistic is the sad truth. Interest rates have historically averaged about 5%, what we live under now is financial repression with the only solutions being further financial engineering. The idea that ZIRP will fix things is the great delusion of our time.
Mark Twain summarized the phenomenon that best describes the mentality of today’s central bankers, particularly our Fed: “To a man with a hammer, everything looks like a nail”. Sad that we cannot understand that simple fact. The Fed’s hammers – ZIRP, QE ad nauseum, and …whatever, are merely hammers looking for “nails”. Si is absolutely correct, our carpenters are delusional and we are powerless to reign in this “independent” lunacy. All other discussions of the subject attempt to ignore the elephant in the room, and this will only lead to more delusions.
I think you are spot on. Instead of paying a reasonable interest rate, ZIRP is forcing people to cast about to find some sort of return. I personally think it is designed for one last fleecing of main street as it encourages people to seek a return on Wall Street. Once main street is all in, the ‘sheep’ will be fleeced one last time. They can’t raise rates now because of the immense gov’t. debt that has been taken on to bail out the banks. But once the middle has been completely hollowed out, it might at last be time for the big reset.
One idea would be that investments should be targeted to reduce EU consumption of fossil fuels. The key would be to make sure that the funds invested went to European firms and European workers.
Personally I would also like to see tariffs increased at EU borders to force companies to re-industrialize Europe. But in a time of deflation there is obviously soom room for money printing to increase demand. Again, the key is to make sure this demand stays in Europe and creates European jobs.
Well written! The simple problem is that you have criminals running the EU therefore nothing they do will help average people, even if the intention is to help them, which it never is. We’ve seen massive money printing for years now. It solves nothing. In fact it hurts the economy, So let’s print more money! Brilliant.
Raising interest rates was a great idea five years ago and it is also a great idea to clean out the rot in the system, however any significant rate rise will pop the global debt bubble now and crash everything. Personally I’d prefer to see that happen immediately, before the US starts WW3 with Russia.
What a lack of imagination you have to think a bust is needed!
Question: Do we still have to dig money out of the ground?
Question: Can money be used to pay off debt?
Question: Is excessive debt the problem?
You should be disturbed that you think misery for very many is required for the sins of a very few.
Now go ahead and whine: “Hyperinflation!”
The ‘many’ already are miserable! The debt bubble and bank bailouts have been a wealth transfer from the many to the few. Take a look at wages over the last 40 odd years. Savers and pensioners have been gutted. Pension promises are based on an 8% return, in reality they will be lucky to get 3%. So pensions 1/3 of what is expected. Have a look at what has happened to the pension fund in Kentucky…. more misery on the way for them.
BTW – money (fiat) IS debt.
I agree on the misery but some won’t be satisfied till soup kitchens are the only means for the poor, if that.
As for fiat, SOME essentially debt-free fiat could accumulate if:
1) The monetary sovereign never runs budget surpluses.
2) Never issues bonds but simply spends new fiat into existence to finance deficits.
3) Has no central bank to muddle things.
Moreover, common stock is a private money form that requires absolutely NO debt at all! But why share when those with equity can legally steal via the government-backed credit cartel?
“”I am finding it problematic when de-facto ‘money printing’/manipulation is used to solve, what appears to be, at least to me, a collapse in demand and structural problems.””
Is it the ‘de-facto part?
I would think that a collapse in demand met by money printing would be fine, if the Euro had anyone capable of such a thing.
That is the tragedy of the EMU.
Absent anyone having the authority and capability to have more money in circulation than the Euro gold standard allows, and given the definitional lack of demand being the source of the European people’s suffering, it seems ‘de-facto’ is going to have to do for the moment…….until the nations figure out something better.
Like monetary sovereignty.
If they still remember.
Yanis makes a lot of sense here. I find it hard not to feel rage at what the hot money did build (e.g. useless ghost cities) and that no useful capacity got built. Somewhere in all this, processes of de-industrialisation, globalisation and neo-liberalism have normalised activity that was previously the exclusive domain of professional criminals. I think we have to be prepared to take that on directly.
Was there any other alternative for the European monetary union except the gold standard given that the union was to be carried out through very different fiscal entities and the currency would not enjoy reserve status as the US dollar does?
Is it really a good idea to unleash QE through investment bonds under low aggregate demand and expected deflation?
There has been much resistance and revolt against EU policies without political effect. But people can vote with their money/resources. They can grow their own food, cut their own hair, make their own booze, repair their own transportation, build their own furniture, etc. They can operate outside of the Mainstream Conglomerate Economy and DEFLATE it. What we may need is more deflation in the right places than less.
Which raises the question: why is the Underground Economy almost always ignored in economic analysis? If I were a Dismal Scientist working for the Dark Side, the first questions I would ask: Underground Economy, is is growing? How fast?
You make Europe sound like it’s full of Henry David Thoreaus. I can’t see Canadians following any of your wise advice. They’d have a fit if you told them they can’t shop at Wal-Mart. And take away their debit cards? Holy Rumplestiltskin! you’d have better luck getting their first born.
Instead of trying to reset to a higher plane of existence, I would prefer to see chapter 7’s and chapter 11’s.
“The ECB did provide massive liquidity to the banks, e.g. under the LTRO, and that did nothing to help…”
Did nothing to help? Well, it did help bring down yields on the eurozone periphery’s sovereign debt.
I would say this result is an impressive success from the eurocrats’ point of view. The sovereign debt situation is now “stabilized”, the sense of looming crisis has vanished and austerity policies can now be pursued with a minimum of opposition. Spain’s ten year bonds today are selling at yields close to the level of U.S. Treasuries of equivalent maturity. If this is not success, I don’t know what is.
It is a serious mistake to underestimate the firepower of the ECB. The bank is the ultimate controller of the euro system. And it’s been ruthlessly efficient at guaranteeing that it is managed according to the interests of Europe’s financial sector.
As for the idea of having the European Council promote a large scale stimulus package, you can forget about it. It’s not in the cards, since it would undermine the prevailing austerity consensus. Varoufakis still seems to live under the illusion of a possible social democratic turn in the European experiment. Alas, social democracy has definitely gone down the drain in Europe, even though many of her ruling parties still insist on calling themselves – absurdly – “socialist” or “social democratic.”
So let’s summarise:
“In our monetary union, the lack of
• a substantial mechanism for recycling surpluses during a crisis from the surplus regions or states to the deficit ones, and
• a mechanism for deep debt restructuring,”
This is just double speak for: 1. Confiscating the funds of the regions and states that have managed their revenues and expenses sensibly and giving it to the proliferate; 2. Trying to come up with a magic trick that allows for a default without a default since with most of the government debt being intimately tied to the $700 TRILLION credit default swap market, we all know that it would bring down the financial market and all of the TBTF banks with it.
As for the idea of the ECB buying EIB bonds, the question is why? When you consider that the EIB has been investing more than €2 billion per year in projects in Africa, Latin American and the Mediterranean for private companies who in a number of cases have managed to fleece the local politicians out of proper compensation for the mineral rights given to these private companies, how does that benefit europe? Even within the EU, there is a real question of the return on investment from the majority of EIB projects.
The whole scheme is a non starter. What needs to be done is for the whole thing to blow up and to start on a more sane basis where state or regional expenses are kept in line with revenues. This obsession about deflation is just silly when more and more people cannot find a job and lack the entrepreneurial capability, due to the poor state of what passes for education within the EU for starting and maintaining a successful enterprise. Printing money to push up the nominal prices is not going to benefit anyone except those who invest in the stock markets as is well evidenced by the $4 trillion plus that the Fed has printed since 2008. The only solution is for everyone to accept that the whole house of cards has to fall.
I fail to see how issuing bonds solves financial fraud, the lack of social consensus on how unified Europe ought to be, or the lack of social consensus on how much Europe should partner with the US empire.
I think Europeans and North Americans are going to have to start getting used to the idea that in the 21st century we are going to need to do a lot more social and economic planning and organizing than we have been accustomed to in the past. The age of rapid development is over and the low-hanging fruit is gone. There are no surges in innovation and low-skill production sucking up unemployed human labor. The market system on its own can no longer allocate people to jobs and incomes to people in a socially acceptable way. We have important public needs that are not being fulfilled and important opportunities for useful employment service to the society that are not being taken because they do not fall under the ordinary purview of private capital and its profit motives; and we have long-term strategic public needs that are not being tackled because governments and public institutions are either subsidiaries of private capital, or for other reasons lack the political will or leadership capacity to take on these projects. Private capital has accomplished a wholesale ejection of tens of millions of people from the labor force, and that situation is gradually being standardized into a new normal as these people give up on the prospect of working, and are thus slowly disappeared from the unemployment rolls. And democracy is in tatters as what were once citizens have been transformed into a a class of dependent consumer-serfs living off either dependency-generating doles or miserable and poorly remunerated labor. Finally, we are all governed by a technocratic elite of Eurocrats, Ivycrats and corporate CEO’s on lend-lease from Wall Street that have almost no democratic spirit or commitment to speak of, and are in many cases downright hostile to democracy. They are the members of a privileged class possessing special forms of human capital – sometimes consisting of social networks, other times consisting of brains built on the right technically adept sort of plan – and are determined above all other aims to preserve the class privilege flowing from those possessions and the basic outlines of the social order that now so heavily depends on them and rewards them. They are responsible for most of the knowledge production in our society, and Job One for the knowledge production elite is thus to deny people an understanding of what is happening to them, and to make sure that when they do glimpse part of truth, they loathe and blame themselves as a result.
There is no way out of this mess that doesn’t begin with people forming new grass roots democratic organizations, and devoting a great deal of time to a reconstitution of democracy from the bottom up, aiming at a gradual but thorough recapture of governmental, social and economic institutions.
In my view the grass-roots organizations have to be collectives/cooperatives/communes/guilds/unions (more inclusive than the old ones) and so on. There is no alternative. If humans want to compete or survive with an increasingly roboticized corporate world they must form their own units to counter the emergent corporate neo-feudal structure. I think the population will soon be ready to form new structures but the only way we can do that is to first come together and build alternative structures and then we can attack the corporate world form a base of power within communities. As it is now we have no power and there is no way, as individual citizens, that we can claim that power without solidarity and militancy.
Sounds similar to some of these proposals..
But what else can the Fed chair do? Actually, quite a lot. Instead of pumping more money into the banking system, where much of it feeds speculation, the chairman should figure out how to get it to the sectors of commerce or industry that really need it.
The Fed could help organize and finance major infrastructure projects, like modernizing the national electrical grid, building high-speed rail systems, and cleaning up after Hurricane Sandy—public works that create jobs the old- fashioned way. The Fed could influence the investment decisions of private capital by backstopping public-private bonds needed to finance the long-neglected overhaul of the nation’s common assets. One recommendation that was floated long ago is to allow state and local governments access to bond markets to finance infrastructure investment at low Treasury rates (through a Federal government guarantee of specified projects).
Alternatively, the Federal government could provide funding to pay the interest (or a portion of it) so long as state and local governments could service the principal.
These are plausible examples of what the central bank might do if it truly tries to fulfill its dual mandate. Orthodox monetary economists will be horrified by such talk: these alternatives, they will say, are technically impossible, maybe even illegal. A few of the suggestions would probably require clarifying legislation and congressional cooperation. But the Fed can carry out direct interventions to help the economy recover because it has done them before. In the 1920s, believe it or not, the Federal Reserve even underwrote the bonuses promised to World War I veterans when private banks wouldn’t honor their certificates of service.
During the Great Depression, the Federal Reserve was given open-ended legal authority under section 13(3) of the FRA (enacted in 1932) to lend to practically anyone if its Board of Governors declared an economic emergency—without approval from Congress.
Whether or not the Fed’s recent interventions during the GFC were justified, the point here is that the central bank was willing to save certain corporate enterprises when it believed the consequences of their failure would threaten the largest banking institutions. Yet, the Fed declined to do something similar for the overall economy and help millions of indebted homeowners and unemployed workers.
The central bank can lend to industrial corporations and small businesses, including partnerships, individuals, and other entities that are not commercial banks or even financial firms. The Fed made thousands of direct loans to private businesses during the New Deal.
Jane D’Arista, author of The Evolution of US Finance147 and a leading reform advocate, insists that the central bank has numerous levers to drive reluctant bankers to support a vigorous recovery with more plentiful lending. “The Federal Reserve as an instrument of credit policy is weak, and right now we need it to be strong,” she said. The Fed could alter reserve requirements to punish bankers or reward them. It could stop paying interest on the enormous idle reserves banks are now sitting on and start charging a penalty rate for banks that won’t use their lending capacity. The Fed can steer banks to neglected categories of lending—small businesses, for instance—by lowering the reserve requirement on those loans. Above all, D’Arista believes, the Fed can simultaneously begin to reform the banking system from the bottom up.
“Let’s forget the big guys,” she said. They’re hopeless. We’re not going to get anywhere with them. However, the community bank is an engine of growth, and here is a way to help them. Community banks are naturally skittish. They need real reassurance for the kind of lending that isn’t corporate-scale. This could also involve them in infrastructure projects initiated by state and local governments. That’s where the Fed’s discount window could come in and help. It is a way of backstopping the little community bank and the medium-sized bank.148
She envisions consortiums of small banks participating in big projects. The Fed could help organize them.
Stephen Sleigh, a labor economist and director of the national pension fund for the International Association of Machinists and Aerospace Workers union, has similar ideas about how the Fed can persuade private capital investment to finance major infrastructure projects. “Part of Bernanke’s strategy of pushing down interest rates, both short-term and long-term, is to force conservative money into investments like construction,” Sleigh observed. “That makes perfect sense, but the capital is not flowing. It’s still on the sidelines. I would love to see the Fed start talking about infrastructure. The Fed needs to be working on new tools and find ways to get the conservative money off the sidelines and start rebuilding the American economy.”149
Conservative investors like pension funds and insurance companies lost an important source of income when the Fed lowered interest rates drastically. Sleigh explained: “As a pension fund manager, I need investments that are going to provide reliable, steady income that can sustain our long-term assumptions. Traditionally, the ten-year Treasury bond was a way to pay the bills, but it doesn’t do that anymore, because it is trading now at less than 2 percent.”
A solution Sleigh envisions would involve bond borrowing for public-private infrastructure
147 Jane D’Arista, The Evolution of US Finance (Armonk: M.E. Sharpe, 1994). 148 Jane D’Arista, interview by William Greider, The Nation, October 9, 2012. 149 Stephen Sleigh, interview by William Greider, The Nation, October 5, 2012.
projects that would be “labor-intensive and great for long-term economic growth and would absolutely help us meet our obligations, because these bonds are going to yield 6 to 8 percent on our investments.”
If this country ever gets back to a time when real questions are asked about democracy and our unrealized aspirations, people and politicians will have to talk about the Federal Reserve and its “money power.” It no longer makes sense to keep fiscal and monetary policy separate, pulling the economy in opposite directions. The present crisis suggests that monetary tools are (and should be) coordinated with the fiscal side—and that could even be strengthened. How this could be done in a democratic way is a tough question, but it is one that can be explored once we peel back the layers of fog that cloud thinking about monetary and fiscal operations. When asked where he got all that money that the Fed was using to purchase assets, Chairman Bernanke correctly answered that the Fed created it. It did not come from taxpayers. If the Fed can spend by “keystroke” to buy financial assets, why can we not find a way for government to spend in the public interest by “keystroke”?
The challenge now is to convince ourselves that money created by government could be used—judiciously—to finance long-term public projects, like infrastructure and high-speed rail. What about Hyman Minsky’s proposal to use government as employer of last resort? Imagine if highest-priority projects were financed with the new money created by the cooperation between the Treasury and the Federal Reserve—breaking in a single stroke the logjam in Washington created by the belief that Uncle Sam has “run out of money” as President Obama wrongly believes.
As much as I’d like to see those things done, I would hate for the Fed to do them. The central bank should not be conducting its own independent and democratically unaccountable fiscal policy.
Fair enough but they’ve already been picking sides and we have a stalled legislative body. They might as well do something useful.
Although it would never happen, the most useful thing the Fed could do is have a presser and say, “The US Congress is economically incompetent and directly responsible through its crackpot negligence for a trail of avoidable human destruction since 2008.”
Yes. They did issue a white paper to Congress. Orin Hatch responded that it would be moral hazard to help homeowners..
If Portugal and Ireland are prime examples of the periphery … both countries have indicated that they are coming out of their debt-crisis all on their own. These two articles from the NYT:
*As regards Portugal, see here.
*As regards Ireland, see here.
And for Spain, the news is a bit more mixed – interest rates have dropped to 2005 levels, but unemployment remains high. Still, nobody expected a quick-fix in Spain, which has a larger manufacturing sector than either Ireland or Portugal.
So that leaves who on the periphery? Ah yes – Greece. Any answers there, YV?
Frankly, it seems the main EU debt-crisis problems seem to be France and Italy. France cannot seem to get its act together, but Renzi in Italy is battling successfully ingrained political powers that wanted no change.
In Italy, fiefdoms are ensconced in an arcane political system ridden with positional sinecures built throughout the postwar years. Caspita!