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November 22, 2005
The Eurozone Game Of Chicken Plays On
A few weeks back, Nouriel Roubini invoked the game of chicken metaphor to describe the current war of wills between Eurozone finance ministers and the European Central Bank, laying out all the ways the game might end:
1. The fiscal authorities blink and they adjust fiscal policy.
2. The ECB blinks and we get higher inflation.
3. Neither side blinks and the unsustainable debt leads to default by some Eurozone countries (this is a form of final blinking by fiscal authorities as they move to a capital levy, i.e. a tax on holders of public debt)
4. The Euro sharply falls reducing the real value of the Euro debt held by foreign (i.e. non EU) residents; this is a capital levy on non residents.
Over at A Few Euros More, Edward Hugh updates us on how the game is progressing. Here's the story in headlines, first from EUobserver...
ECB set to clash with eurozone ministers after rates increase
...and again...
Trichet says interest rates rise good for EU citizens
... followed by this, from the Financial Times:
ECB has ‘no plans’ for series of rate rises
The "series of rate rises" is the key qualifier there, as the expectation is still that rate hikes are a-comin':
The ECB is expected to raise rates in December for the first time in more than two years...
His comments, which led to the euro falling against the dollar, reinforced many economists’ expectations that the ECB will follow a quarter percentage point increase next month with maybe a further increase early next year before pausing. But Mr Trichet defended strongly the ECB’s decision to lift rates from the 2 per cent level that has remained unchanged since June 2003...
The ECB’s willingness to raise interest rates has pitted central bankers against finance ministers. Jean-Claude Juncker, the Luxembourg prime minister and the political “Mr Euro”, said on Monday that higher oil prices were not feeding through into higher wages. “I have said on several occasions that there are no second round effects of wages policy and therefore there is no need to raise interest rates,” he said.
Mr Juncker’s comments reflect the views of many of the 12 eurozone finance ministers, whose monthly meeting he chairs.
As I noted in earlier post, the modern judgment is that a blinking central bank does no one any good. But, as Mark Thoma warned us just the other day, that independence shouldn't be taken for granted -- right before showing this picture of why many are convinced it really matters:
That evidence was collected and analyzed well before the creation of the ECB -- see Mark's post for the citation (and contrary opinions). It's pretty interesting to be watching another data point in the making.
UPDATE: Edward Hugh channels the Financial Times Paul de Grauwe, who argues that the ECB may be overplaying thr inflation scare. Toni Straka finds that the folks at Deutsche Bank may be thinking the same thing (although he is not enthusiastic about their use of core inflation in coming to that conclusion). On the other hand, The Skeptical Speculator notes some good news on eruozone industrial production (along with the usual great roundup of other world economic news).
November 22, 2005 in Europe | Permalink
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» Sobering News from A Few Euros More
First off, Dave at MacroBlog has a good summary of the core of the economic policy programme adopted by the new German government. He also has some to the point comments about ECB credibility issues But the big news today... [Read More]
Tracked on Nov 23, 2005 2:11:47 AM
» Sobering News from A Few Euros More
First off, Dave at MacroBlog has a good summary of the core of the economic policy programme adopted by the new German government. He also has some to-the-point comments about ECB credibility issues But the big news today must surely... [Read More]
Tracked on Nov 23, 2005 2:24:19 AM
Comments
Posted by:
Edward Hugh |
November 23, 2005 at 01:17 AM
Don't miss this little detail in the FT today:
"The European Central Bank’s decision to press ahead with a rate increase next month was indicated by Jean-Claude Trichet, ECB president, last week.
The move prompted speculation that he had been bounced into exerting his authority by signs of disagreement among members of its 18-strong governing council."
If you can't stand the heat.......
Posted by:
Edward Hugh |
November 23, 2005 at 02:27 AM
I've just come up with some more conment on all this in the FT. The point is all of this is hopelessly 'inept'. Former BoE monetary policy committee member Charles Goodhart has been a pretty vociferous critic of how these things are handled in Frankfurt. I basically agree with him, and tend to feel sorry for Mark Thoma (and of course the market participants) earnestly trying to make sense of the message. Since before Trichet the blame was put on the 'wooden footed' Duisenberg, and now history is repeating itself, oughtn't we to look at something in the institutional framework that is producing what can only be described as an ongoing 'comedy of errors'?
Now for the FT:
"The euro fell from a two-week high against the dollar after European Central Bank president Jean Claude-Trichet reined in expectations that the bank was poised to embark on a series of interest rate rises."
"On Friday he signalled the eurozone central bank would raise interest rates in December and the market pencilled in further tightening early in 2006. However, on Monday, in testimony to the European Parliament’s Committee on Economic and Monetary Affairs, he said: “it would not be a good working assumption to consider that we are at the start of a series of interest rate increases.”"
"“Mr Trichet is guilty of introducing excessive volatility in the eurodollar on an intraday basis,” Paul Mackel of ABN Amro said. “Some are scratching their heads wondering what is the message the ECB is trying to convey,”"
Well, leaving people scratching their heads wondering certainly isn't supposed to be part of his job specification.
Posted by:
Edward Hugh |
November 23, 2005 at 02:43 AM
For anyone who accepts the “game of chicken” story as you and Roubini tell it, it must be quite clear who is wearing the black hats and who is wearing the white hats. After all, if the finance ministers win, we get “higher inflation”, which everyone knows is bad, and if the ECB wins, we get fiscal discipline, which everyone knows is good.
But I would consider another possible outcome: “2 ½. The ECB blinks and we don’t get higher inflation.” I haven’t read all the statements from the finance ministers, but I don’t think they are generally advocating higher inflation rates. Rather they have different ideas about what policies will produce inflation. Should one rule out the possibility that they are right and the ECB is wrong?
(Granted, if you believe in a strictly monotonic Phillips curve or the equivalent, then easier monetary policy, along with continued fiscal stimulus, would inevitably produce inflation that is at least a little bit “higher” than would otherwise be the case, but not necessarily higher than the current inflation rate.)
Posted by:
knzn |
November 23, 2005 at 02:27 PM
knzn -- I don't really see much in the way of alternatives to the game of chicken scenarios Nouriel lays out. The long-term budget contraint has to be honored -- that is, reveneus must ulitmately match expenditure. If the Treasury arm of the government does not do it, what is left but monetary policy? Maybe your argument is that circumstance is not so dire as made out? Or that euro countries (and the US) for that matter have enough credibility for ulitmately coming to the right conclusion that these deficits can run for a very long time without adverse consequences for inflation?
Posted by:
Dave Altig |
November 24, 2005 at 07:11 AM
The latter (I think, though your wording confuses me). If there is a sufficient demand for money, deficits can be financed with seignorage without producing inflation. The experience of Japan indicates that, in some cases, this can be done on a very large scale for a long time. Europe obviously isn’t Japan, but it seems to me there is room for a variety of opinions about where Europe falls on the continuum. I would imagine that the finance ministers realize they eventually will have to reduce their deficits, but eventually could be as long as a decade or more, and it could happen through economic growth rather than changes in fiscal policy.
(As an aside, I note that seignorage could be indirect. The ECB does not have to accept a nation’s bonds as collateral in order to help finance that nation’s deficit. For example, the ECB buys German bonds; then whoever would have bought the German bonds is forced to look elsewhere and perhaps buys Italian bonds.)
Posted by:
knzn |
November 24, 2005 at 10:23 AM
Another issue: Should possibilities 2 and 4 really be separated? If the Euro plummets and the ECB doesn’t do anything about it, doesn’t that count as blinking?
Posted by:
knzn |
November 24, 2005 at 05:50 PM
Yes, I think you're getting the message loud and clear. I think we have the first major test of the institutional credibility of the ECB now looming on the horizon.
I suppose the incidental detail of interest would be that when Trichet was appointed, there was some concern that French political influences might carry excessive weight. Curiously, if you look exclusively at the French economy, the measured rate rise approach (or removing accommodation) would be thoroughly justified (and indeed Christian Noyer, head of the Bank de France has been a 'relative hawk'). This time it is from Germany that the biggest pressure is coming (I mean I think we can discount Italy as a major source of influence at the ECB these days).
This account from Joaquim Fels of the meeting which sparked the debate is well worth a read:
http://www.morganstanley.com/GEFdata/digests/20051121-mon.html#anchor2
In particular this bit:
"With hindsight, the dramaturgy was wonderful. In the first session of the day, the Italian Vice Minister for the Economy, Mario Baldassarri, when responding to Bundesbank President Axel Weber’s introductory speech on global imbalances, suggested that a much weaker euro would be a good thing for Europe. To clarify what he had in mind, I asked him in the Q & A whether he was suggesting that the ECB should target the exchange rate. His response was that he thought the ECB should not raise rates until the EUR/USD rate had fallen to parity. Axel Weber, who sat next to him, kept a straight face, well knowing what Jean-Claude Trichet would announce a couple of hours later. He confined himself to the comment that “this is not our strategy.”
Modigliani used to argue that the at the Bundesbank they were obsessed (and in his view unduly so) with only one thing: fighting inflation. My how times have changed."
Also note how the European debate has also sucked in the IMF, since Rodrigo Rato is participating:
"More surprising in my view is the insistence expressed by international organisations such as the IMF to oppose a rate hike by the ECB. Managing Director Rodrigo Rato said for instance that “it would be good to see more internally driven recovery” before starting to normalise interest rates."
Eric Chaney
http://www.morganstanley.com/GEFdata/digests/20051121-mon.html#anchor4
This is very hard to read, since Rato, being a Spanish politician, and Spain being the 'big four' European economy most in need of an increase (negative interests rates, massive and sustained housing boom, CPI in the 3.5 to 4% range). But then maybe Mr Rato's post IMF ambitions are not to return to Spain, but to move to Brussels.
The thing is, are we talking about Germany here, or about the 'eurozone'. Bottom line: it's a mess, awaiting more developments.