Europe’s other taboo: reform of the ECB

At a recent meeting of European economists I remarked that there were two big taboo subjects when discussing how the Eurozone might be improved. The first, which I have talked about before, is countercyclical national policies, which could include macroprudential monetary policies but which also must include fiscal policy. It is blindingly obvious that such policies, if implemented, would have put the Eurozone in a much better position before the 2010 crisis, but despite this the subject remains ‘off the agenda’.

The second taboo subject is reform of the ECB. Once again, it is pretty clear to anyone outside the Eurozone that since 2010 ECB decisions have been very poor, both in absolute terms and relative to their counterparts in the US, Japan and the UK. The three big errors are well known:

1. A failure to introduce OMT in 2010, delaying it to September 2012
   
   
2. Raising interest rates in 2011
   
   
3. Delaying Quantitative Easing until 2015

No one disputes (2). Some say that (1) and maybe (3) were because the ECB had to wait until it was clear that particular countries were serious about undertaking ‘reforms’. This explanation raises more questions than it answers. The ECB’s remit does not extend to dictating national economic policies, but sometimes the ECB appears to think otherwise.

Alongside these big errors are many examples of ECB actions which are highly questionable, the most recent involving Greece. Imagine the Bank of England cutting off the supply of cash to Scotland if negotiations between the Scottish and UK governments were not going the way the UK wanted. Those who say the ECB was only following its rules neglect to observe that the ECB makes up its rules as it goes along. Even in more minor matters, actions of ECB officials which would do more than raise eyebrows elsewhere go on for years without anyone finding out.

One major error alone might not be enough to indicate reform, but three suggests that structural reform is essential. Yet the one structural reform no one in the Eurozone will talk about is at the heart of the Eurozone itself. The reason of course is also why no one will talk about countercyclical fiscal policy: it does not fit in with the dominant German narrative. What is a shame is that this taboo among policy makers is infectious: at the meeting where I talked about this taboo only one or two others mentioned the ECB.

This is a shame, because some imagination is required in thinking about ECB reform. A reasonably obvious change to make is to take monetary policy decisions away from the exclusive control of central bankers, along UK lines. But who would appoint any external members? Here we have a tricky problem - the lack of political union means that any political accountability may be too diffuse to be effective (as it is at present). But the point of this post is not to offer solutions, but to complain that not enough people are talking about the problem.

Greece and Trust

Nick Rowe pulls me up on a point that I didn’t make in my account of what should have happened to Greece after 2010. I argued that some external body (e.g. IMF) should lend sufficient money for Greece to be able to achieve primary surplus (taxes less non-interest government spending) gradually, thereby avoiding unnecessary unemployment. Gradual adjustment is required because the improvement in competitiveness required to achieve ‘full employment’ with a primary surplus cannot happen overnight because of price rigidity.

Nick’s point is that for this to happen, the external body has to have a degree of trust in Greece: trust that it will not take the money and at some stage default on this new loan. This trust may be particularly problematic if Greece had defaulted on its original debt, which I think it should have done. This, after all, is one reason why Greece would not be able to get such finance from the markets.

This is what the IMF is for. Governments are more reluctant to upset the international community, and so defaults on IMF loans are rare. As Ken Rogoff writes: “Although some countries have gone into arrears, almost all have eventually repaid the IMF: the actual realized historical default rate is virtually nil.”

But does this help explain why other Eurozone countries keep going on about how Greece has lost their trust? I think the answer is a clear no. In fact I would go further: I think this talk of lost trust is largely spin. The issue of trust might have explained the total amount the Troika lent from 2010 to 2012. However, as I have said often, the mistake was not that the total sum lent to Greece was insufficient, but that far too much of it went to bail out Greece’s private sector creditors, and too little went to ease the transition to primary surplus. (The mistake is hardly ever acknowledged by the Troika’s supporters. Martin Sandbu discusses the - misguided - reasons for that mistake. [0])

The reason the Troika give for lack of trust is that Greece has repeatedly ‘failed to deliver’ on the various conditions that the Troika imposed in exchange for its loans. The Troika has tried to micromanage Greece to such an extent that there will always be ‘structural reforms’ that were not implemented, and it is very difficult to aggregate structural reforms. However this is exactly what the OECD tries to do in this document, and if I read Figure 1.2 (first panel) correctly, Greece has implemented more reform from 2011 to 2014 than any other country. [1] We can more easily quantify austerity, and here it is clear that Greece has implemented almost twice as much austerity as any other country. [4] The narrative about failing to deliver is just an attempt to disguise the fact that the Troika has largely run the Greek economy for the last five years and is therefore responsible for the results. [3]

You could argue with much more justification that the failure of trust has been on the Troika’s side. Greece was told that the austerity demanded of it would have just a small impact on growth and unemployment, and the Troika were completely wrong. They were then told if they only implemented all these structural reforms, things would come good, and they have not. You could reasonably say that the election of Syriza resulted from a realisation in Greece that the trust they had placed in the Troika was misguided.

Given these failures by the Troika, a reasonable response to the election of Syriza would have been to acknowledge past mistakes, and enter genuine negotiations. [2] After all, as Martin Sandbu points out in a separate piece, a pause in austerity in 2014 had allowed growth to return, and because Greece had achieved primary surplus new loans were only required to repay old loans. But it is now pretty clear that large parts of the Troika never had any real wish to reach an agreement. Over the last few months we were told (and the media dutifully repeated) that the lack of any agreement was because the ‘irresponsible adolescents’ of Syriza did not know how to negotiate and kept changing their minds. We now know that this was yet more spin to hide the truth that large parts of the Troika wanted Grexit.

The lesson of the last few months, and particularly the last few days, is not that Greece failed to gain the trust of the Troika. It is that creditors can be stupidly cruel, and when those creditors control your currency there is very little the debtor can do about it. 

 

[0] Greece was prevented from defaulting because of fears of contagion of one kind or another, which meant that Greece was taking on a burden for the sake of the rest of the Eurozone. The right response to these fears was OMT, and direct assistance to private banks, as Ashoka Mody explains clearly here. But given that this was not done, what should have then happened is that once that fear had passed, the debt should have been written off. But politicians cannot admit to what they did, so the debt that was once owed to private creditors and is now owed to the Troika remains non-negotiable.

 

[1] The Troika can also speak with forked tongues on this issue: see Mean Squared Errors here (HT MT).

[2] I am often told that the Troika had to stand firm because of a moral hazard problem: if Greek debts were written down, other countries would want the same. But the moral hazard argument has to be used proportionately. Crashing an economy to avoid others asking for debt reductions is the equivalent of the practice in 18th century England of hanging pickpockets.

[3] I am sometimes asked why I focus on the failures of the Troika rather than the mistakes of Syriza. The answer is straightforward - it is Troika policy that is the major influence on what happens in Greece. And when the Troika gives Greece’s leaders the choice between two different disasters, it seems rather strange to focus on the behaviour of Greece’s leaders.

[4] Postscript: Peter Doyle suggests that, all things considered, Greece overachieved on fiscal adjustment