Winner of the New Statesman SPERI Prize in Political Economy 2016

Friday 16 December 2011

Starting a blog, and the role of the ECB in the Euro crisis

I’ve occasionally written short pieces for my homepage that reflect on current macro events, policy or theory. They are often provoked by apparent disagreement among macroeconomists: whether to raise UK interest rates in early 2011 was one recent example. They are the kind of thing you find in newspaper articles, but which I have not tried to place there either because I did not have time, or because how you go about doing this remains mysterious to me. However there are many occasions where most macroeconomists agree on what is going on or what should be done, but that message does not feature sufficiently in the public debate. Rather than shout once more at the TV screen or radio, I thought I would start a blog.
                Here is one example I heard today, but which has been repeated over and over again when discussing the reaction of Eurozone policymakers to the current crisis. Whatever measures are being taken to reduce budget deficits, in either particular countries or by changing Eurozone rules, it is often asked ‘will this convince the markets’. The clear implication is that with enough austerity, markets will happily go back to buying debt without demanding high interest rates to compensate for default risk.
                It is not at all clear that this is what is really going on. Part of the risk that markets are concerned about is that countries may be forced to abandon the Euro. The greater the austerity, the greater this danger. However, what would convince the markets at a stroke would be if the ECB intervened by buying government debt in an aggressive manner to lower market yields. We have a government debt problem that is confined to the Eurozone not because debt to GDP ratios are particularly high in these Eurozone countries (as the chairman of the French central bank, Christian Noyer, recently noted), but because it is not clear if the ECB will act as a lender of last resort to these governments. (This point is elaborated on at here, and see in particular the referenced paper by Paul De Grauwe.)
                So the impact of any policy measures will depend on whether it convinces the ECB to act as a lender of last resort. Crucial, therefore, is what the ECB thinks. Is the ECB waiting for enough to be done before providing a strong market signal, or is it fundamentally opposed to acting as a lender of last resort? A third possibility is that it is playing a game whereby an on-going crisis is necessary to apply continuing pressure to reduce budget deficits.
                Why is it important to mention the ECB in any discussion linking policy actions to interest rates on government debt? Because it highlights the role of an (unelected) economic institution that we hope is acting in the Eurozone’s best interests, but could instead be acting in a dangerous manner because of a distorted macroeconomic viewpoint. Unless we know for certain that the first of these alternatives is true, we might well ask whether it is wise to rest such power in the hands of a small group that appear democratically unaccountable. I’m not sure what the answer to this question is, but I think it is a question that should be asked more often.
                So, this is why I’m starting a blog. I regard my own views as fairly mainstream, although what is mainstream and what is not is sometimes unclear even to economists, and much less clear in the media. I’m certainly not the most brilliant or exciting macroeconomist in the UK at the moment, but I like to think that I have done enough in the past in contributing to the academic and policy debate to know when I have something interesting or important to say, or when I should stay quiet and do some more thinking. I hope the entries will by and large be accessible to non-economists, although hopefully of some interest to economics students and maybe even academic colleagues. If they are technical, I will try and signal this at the start.

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