A subsidy leads to inflation
Inflation and deleveraging – No global inflation risk, but a serious deflation risk
The ECB's bailouts have come under fire: there are fears that they could lead to rising inflation rates. The authors of the talk do not see this danger. Rather, a moderate rise in inflation could even help to reduce national debt more quickly. The authors from the DIW, however, see the reintroduction of the wealth tax and a one-off wealth tax as a fairer and more transparent alternative.
Monetary policy as a "crisis fire brigade" - is there a threat of inflation?
Thomas Straubhaar, Henning Vöpel
The European Central Bank (ECB) has made it clear which monetary policy course it wants to take. ECB President Draghi announced that monetary policy “will do whatever is necessary within the framework of its mandate to preserve the euro. And believe me - it will be enough. ”1 Draghi has still left it open as to what exactly a concerted action by the ECB and the future euro bailout fund ESM for the purchase of government bonds will look like; the announcement alone is unlikely to be enough. It also remains unclear what conditions over-indebted euro countries will have to meet in order to receive aid. But there is no doubt that the ECB is ready to play the role of the euro savior in the short term. Even publicly communicated interest rate caps for the crisis countries are under discussion. This raises the question of what consequences can be expected from an expansionary monetary policy by the ECB. And even more, whether it is even suitable for solving the crisis.
German versus Anglo-Saxon perspective
In Germany, many decision-makers react blankly, sometimes angry, to the ECB's monetary policy offensive. The ECB's policy is criticized as a "weapon of destruction of assets", "inflation machine" or "license to print money" .2 The intention of the ECB to use freshly printed money to give crisis countries that no longer receive new loans from private creditors to refinance old debts. Protecting against state bankruptcy is the end of monetary stability. This would break the promise of political stability for the euro that was made at the beginning of monetary union.
The German expectation corresponds to the monetarist textbook. Accordingly, it is only a matter of time before an expansion of the central bank money supply beyond the growth of the real gross domestic product inevitably leads to an inflationary development. The costs of inflation - especially high and volatile inflation rates - are well known: diverse redistributive effects (intended and unintentional), distorted allocation decisions and the danger of self-accelerating, hardly controllable inflation processes.
For the (Anglo-Saxon) point of view, the concept of the optimal inflation rate is often used.3 Accordingly, inflation can also lead to positive macroeconomic effects. Firstly, the creation of money gives public budgets the opportunity to generate income, which then serves as an alternative to borrowing or taxes (seigniorage). Second, negative real interest rates can become an effective instrument of stabilization policy. And thirdly, the illusion of money associated with inflation can be used to still be able to lower real wages or - as in the current crisis - to devalue nominal debt in real terms with nominal wages that are rigid downwards (which is often the case in reality). If the current crisis is viewed as a rare occurrence, the (one-off) generation of inflation may not cause time consistency problems for monetary policy. With permanent accommodation, however, inflation expectations are likely to adjust quickly.
Summarizing the monetary policy controversy, it becomes clear that from a German perspective, inflation is the “sand in the gears” of the economy, but from the Anglo-Saxon understanding it acts as “lubricating oil” the lower bound may act a little more inflation than lube oil at low inflation rates; but if inflation rises strong enough, it puts a spanner in the works. ”5
Olivier Blanchard, then chief economist of the International Monetary Fund (IMF), used the ideas of the concept of optimal inflation rates in February 2010 for a concrete proposal for future ECB policy. He formulated his findings from the financial market crisis, which developed into a sovereign debt crisis, in the question: “Should policymakers therefore aim for a higher target inflation rate in normal times, in order to increase the room for monetary policy to react to such shocks? To be concrete, are the net costs of inflation much higher at, say, 4 percent than at 2 percent, the current target range? Is it more difficult to anchor expectations at 4 percent than at 2 percent? ”6 In response to Blanchard's proposal, a heated discussion broke out about the causes and consequences, as well as the advantages and disadvantages of an expansionary monetary policy, which could also lead to higher inflation rates. 7 A new study by the IMF agrees with the opponents rather than the supporters of higher inflation rates. Apparently, after the financial market crisis, what was true before, namely that "an increase in inflation targets gives rise to additional welfare costs, even after the extra room to maneuver above the zero lower bound for nominal policy rates is taken into account." 8
Opponents of an overly expansionary monetary policy finally object that the Federal Reserve Bank's loose monetary policy in the past - with a view to the US housing bubble - itself was more of a cause of instability and it would be paradoxical to continue it to combat its consequences. This view follows the Austrian overinvestment theory: If the monetary interest rate were lowered below Wicksell’s "natural interest rate", more investments would be (pre-) financed than would be available in real terms through savings. There is not only inflation, but such “forced saving” leads to overinvestment and a macroeconomic imbalance between investment and consumption. Overcapacities would be built up and lead to a crisis in which an adjustment took place and had to take place in order to separate the bad from the good investments. In this situation, an expansionary monetary policy would only delay the necessary adjustments and possibly cause new crises
However, it is unclear whether expansionary monetary policy will really lead to bubbles in asset markets. In the case of the US housing bubble, it was actually only a government home ownership program by the Clinton administration that channeled the abundant liquidity into certain markets - especially the subprime segment - and thus contributed to the emergence of the bubble. Conversely, it is just as doubtful whether monetary policy has the instruments to reliably identify bubbles at all, and even more whether it should specifically combat the formation of bubbles in addition to an adequate supply of liquidity to the economy.10
Historically, “political inflation” was often used by governments to devalue debt in real terms through inflation and to redirect resources to themselves. Both the tax monopoly and the money spending monopoly rested with the state. It was often less of a problem to “finance” government debt through inflation than through taxes. An independent central bank should actually institutionally exclude this type of debt financing. The new discussions about equipping the European Stabilization Mechanism (ESM) with a banking license that could grant states permanent (and unlimited?) Access to ECB loans point to precisely this connection.
The question remains, however, whether “a little more” inflation might still help to resolve the crisis. Obviously, shifting the costs of the crisis from the banks and private creditors to the states, or ultimately only replacing a banking crisis with a sovereign debt crisis, has been of little use so far. In the end, one way or another, the cost of the crisis will have to be borne. The decisive factor is how these costs can be distributed in a sustainable manner for everyone. A historically well-documented approach to distribute costs more evenly and - perhaps hopefully - more insidiously and therefore unnoticed is the generation of higher inflation.
Money supply and inflation
There is a number of empirical studies on the general relationship between monetary growth and inflation. However, the evidence is inconsistent. As a result, it can be stated that the relationship between the quantity equation is only valid over the long term and, secondly, at rather high inflation rates.11 Against this background, some questions remain unanswered in the current controversy about the future direction of ECB monetary policy beyond ideological debates. The most important is whether the ECB's crisis policy conflicts with the goal of price stability. During the crisis, the ECB increasingly adopted an unorthodox monetary policy; it bought government bonds from the crisis countries on the secondary market and carried out longer-term refinancing transactions that are rather unusual in “normal” times. In two tenders on December 22, 2011 and March 1, 2012, the ECB allocated around EUR 1 trillion at an interest rate of 1% over three years to commercial banks in the euro system. Most recently, the ECB lowered the deposit rate, which is the rate at which the commercial banks can hold reserves at the central bank, to 0% so that the commercial banks do not hold the money as excess reserves, but also pass on the monetary policy impulse through lending.
In the medium term, however, there is no discernible risk of inflation. In the euro area, capacities are underutilized, economic growth is weak, unemployment remains high, private consumer demand is sluggish and the state will have to consolidate public budgets over the years. In such a recessive environment, the emergence of an uncontrollable wage-price spiral is unlikely. Rather, there is a risk of deflationary tendencies. An expansion of the monetary base would therefore hardly have any effect on inflation at the moment. Greater risks are currently more likely from possible asset price inflation and the emergence of new price bubbles. Rising share prices, raw material and precious metal as well as real estate prices indicate a flight into real assets - driven by concerns about rising inflation in the long term.
In addition, unlike an expansive monetary policy, restrictive monetary policy can always be carried out. The ECB has the option at any time to siphon off the currently additionally created liquidity and thus “sterilize” the purchase of government bonds. You can either lend less to banks. Or it offers banks such an attractive interest rate for time deposits that the central bank money flows straight back to the ECB via this channel. In both cases the monetary base does not increase. And thus the risk of inflation does not increase either. This is exactly the strategy that the ECB has so far followed.12 Central bankers fear deflation no less than inflation. At the moment, therefore, a decidedly expansionary monetary policy seems to be the lower risk. In the euro area, too, a renewed recession could more likely lead to deflation risks again. In this case, the use of unconventional instruments of the ECB would be urgently indicated, even according to monetarist orthodoxy.
Low credit creation by commercial banks
And even an increase in the monetary base does not necessarily lead to inflation. The money supply expands endogenously through credit creation by commercial banks. In addition to a corresponding demand for credit, the prerequisite for an increasing money supply is the willingness of the banks to grant loans.13 The decisive factor is therefore the multiplier with which the financial sector reacts to the additional liquidity made available by the ECB. And there is currently no danger here. The M3 money supply grew less than 3% in the summer of 2012 compared to the previous year.14 A reference value of 4.5% annually is used as a benchmark. Apparently, banks prefer to deposit the money they have borrowed from the ECB back with the ECB instead of using it to create loans. The inflation potential of additional liquidity is currently also being reduced by the increased demand for money, because money holdings increase in crises with low interest rates and high uncertainty.15 The question, however, will be how quickly the ECB can siphon off the expanded liquidity again when the economy picks up again the demand for money and the money supply multiplier should normalize.
Finally, the causality of monetary growth and inflation is no longer as clear-cut today as it was in earlier times. The monetary policy transmission channels in a globally highly intertwined world economy with the free movement of capital follow different mechanisms than in historical times when economies were more closed.16 Therefore, doubts are raised as to whether the experiences of the 1920s can be carried over to the present day. Historically, high inflation was often closely related to the respective exchange rate regime, such as in the times of the gold standard or Bretton Woods, when national monetary policy had to support fixed exchange rates through interventions in the foreign exchange market, which led to corresponding changes in the domestic monetary base.
Non-optimal currency area
Against the background of what has been said so far, the current discussion of ECB policy is crucially concerned with the question of whether the ECB's purchase of government bonds is a one-off act of fighting the crisis - and in this respect a justified exception. Or whether the ECB is at the beginning of a permanent "repair function" in which the ECB has to permanently accommodate the structural deficits of the euro area in order to prevent a breakup. In this case, an intervention by the ECB would have far-reaching implications for the credibility of monetary policy: It marked the transition from a rule-based to a more discretionary monetary policy, which would have the task of stabilizing a non-optimal currency area on a case-by-case basis. Such a role of monetary policy could - so the fear - delay the necessary process of convergence of the euro countries to an optimal currency area, because it reduced the reform pressure on the crisis countries. The consequence would be rising inflation expectations, because the countries would then only face extremely “soft budget restrictions”. In this respect, short-term aid must not come into conflict with long-term convergence goals. They could be designed to be incentive-compatible by formally applying to the ESM with the explicit willingness to have the reform process monitored.
The call for the ECB to play a more active role is based on the assessment that the euro crisis was primarily a crisis of confidence and that the increased market interest rates for government bonds were not fundamentally justified, but were the result of a market panic. Indeed, there is much to suggest that the current problems in the euro area are the result of a suboptimal currency area in which there are no adequate real adjustment and compensation mechanisms to reduce internal imbalances in the form of current account deficits and surpluses. If the finding that the current sovereign debt and balance of payments crisis is the result of a suboptimal currency area is correct, then we cannot assume a temporary intervention by the ECB, but a permanent "repair function" in which the ECB would be entrusted with quasi-fiscal tasks . With the purchase of government bonds, internal imbalances are reduced by monetizing unsustainable national debt and indirectly financing current account deficits, for example through the Target2 balances or a redistribution of reserves between national banking sectors.17 In addition to rising inflation, such a monetary policy also implied an implicit redistribution mechanism.
On the future role of the ECB
Not least because of the influence of the Deutsche Bundesbank, the previous monetary policy of the ECB was stability-oriented. It was thus possible to transfer the Bundesbank's reputation institutionally to the ECB. The US Fed, on the other hand, has always been seen as more pragmatic about the general macroeconomic situation. Historically, the US trauma is high unemployment during the Great Depression; the trauma of the Germans is the hyperinflation of the 1920s; Both (essentially different) traumas have a psychopolitical effect, once in Europe and for another reason in the USA, to this day.
If the euro area is viewed as a “large” economy, then the ECB could also move on to making employment targets more the subject of monetary policy, following the example of the Fed. However, the Fed acts - and this is the decisive difference to the ECB - in an environment that is more appropriate to the situation of an optimal currency area and thus under a different institutional setting.The ECB is required to pursue a policy that is strictly bound by rules in the euro area, as otherwise it could get caught up in the conflict of asymmetric interests of countries.
The normative question of what monetary policy should do, conversely, depends on the theoretically positive question of what monetary policy can do at all. Apart from short-term stabilization effects, which monetary policy has undisputed, it cannot permanently accommodate real adjustment processes in the long term without generating inflation. For this reason, a “yes” to a more active role of the ECB in solving an acute crisis of confidence, but an equally clear “no” to a monetary policy as a substitute for structural convergence of the euro countries on the way to an optimal currency area. On the contrary: It would be the task of politicians to take appropriate convergence precautions to protect the ECB from a role that it ultimately cannot fulfill. In the acute crisis, for which politicians were not adequately prepared institutionally and, as a result, are not sufficiently capable of acting, the ECB must and must make its contribution; in the long term, it must urgently be protected from this - otherwise inflation actually threatens.
- 1 Quoted from http://www.spiegel.de/wirtschaft/unternehmen/zinsentendung-ezb-verzierter-auf-zinssenkung-a-847856.html (8/8/2012)
- 2 Cf. various judgments in Welt-Online from 1.8.2011, http://www.welt.de/print/die_welt/article108430284/Berlin-gegen-Lianz-zum-Gelddrucken.html (8.8.2012); and also R. Brüderle: No license to print money, in: Thüringer Allgemeine Zeitung from 6/8/2012, http://www.thueringer-allgemeine.de/web/zgt/politik/detail/-/specific/Der-Gastkommentar- No-license-to-print-money-343089707 (8/8/2012).
- 3 For the concept of the optimal inflation rate, see S. Schmitt-Grohé, M. Uríbe: The Optimal Rate Of Inflation, in: BM Friedman, M. Woodford (Eds.): Handbook of Monetary Economics, San Diego, Amsterdam 2011, Vol. 3B , Chapter 13, pp. 653-722.
- 4 The metaphor comes from O. Blanchard, G. Illing: Makroökonomie, Munich 2004, 3rd edition, p. 745.
- 5 Ibid, p. 745.
- 6 O. Blanchard, G. Dell’Ariccia, P. Mauro: Rethinking Macroeconomic Policy, IMF Staff Position Note SPN / 10/03, Washington DC, February 12, 2010, p. 11.
- 7 Cf. for the guild of proponents P. Krugman: The Case For Higher Inflation, http://krugman.blogs.nytimes.com/2010/02/13/the-case-for-higher-inflation/ (8/8/2012 ).
- 8 E. B. Yehoue: On Price Stability and Welfare, IMF Working Paper WP / 12/189, Washington DC, July 2012, abstract and p. 4.
- 9 For Keynes, on the other hand, monetary policy is an instrument of stabilization and the interest rate is not a real but a monetary variable. In the event of underemployment, the central bank can cut interest rates to stimulate investment demand. When capacities are underutilized, investments are not only limited by the amount of savings, but can "create" their own savings by expanding production.
- 10 See B. Bernanke: Asset-Price Bubbles and Monetary Policy, Remarks by Governor Ben S. Bernanke, October 15, 2002.
- 11 Cf. P. Teles, H. Uhlig: Is Quantity Theory Still Alive ?, CEPR Discussion Paper, No. 8049, 2010.
- 12 Cf. Council of Experts on the Assessment of Macroeconomic Development: Taking Responsibility for Europe, Annual Report 2011/12, Wiesbaden 2011, p. 107.
- 13 The idea of a largely endogenous money supply is pursued in post-Keynesian theory.
- 14 European Central Bank: Monthly Report July 2012, Frankfurt a.M., p. 17.
- 15 Cf. M. Faig, B. Jerez: Precautionary Balances and the Velocity of Circulation of Money, in: Journal of Money, Credit and Banking, vol. 39 (2007), no. 4, pp. 843-873, die Interestingly enough, the USA saw a significant decline in money holdings as early as 2004 due to the precautionary motive, which is likely to have given additional impetus to the formation of bubbles on the US real estate market.
- 16 The keywords here are “carry trades” or “offshore banking”.
- 17 For a discussion see H.-W. Sinn, T. Wollmershäuser: Target Loans, Current Account Balances and Capital Flows: The ECB’s Rescue Facility, NBER Working Paper, No. 17626, 2011.
Communication problems of unconventional monetary policy
Prominent US economists have vehemently criticized the policy of the Japanese central bank as being too passive during the period of stagnation. The current policy of the US Federal Reserve seems in some respects to be almost a copy of the strategy in Japan - a consequence of high uncertainty about the appropriate communication strategy. Explicit control of nominal GDP could point a way out.
After the real estate and equity bubble burst, the Japanese economy entered a prolonged phase of stagnation in the early 1990s. Although the central bank eventually cut the key rate from 8% to zero, there was no recovery. Ten years later - after the first “lost decade” - Milton Friedman1 sharply criticized the policy of the Japanese central bank at a keynote lecture by the Bank of Canada: “The example of Japan shows how unreliable interest rates are as an indicator of an appropriate monetary policy. The Japanese central bank operated a zero interest rate policy. But this zero interest rate policy is a sign of an extremely restrictive monetary policy. Japan was effectively in a period of deflation. The real interest rate was positive, not negative. What Japan needed was additional liquidity ... Japan fell into recession in 1989 and has been in it ever since. The growth of the money supply was too low. The Japanese central bank's argument is, 'Well, we've already cut rates to zero - what else should we do?' The answer is simple: You can buy long-term government bonds and you can keep doing so until the rising monetary base brings the economy back on track. What Japan needs is a more expansionary monetary policy. "
Developments in Japan brought the limits of conventional monetary policy to the fore as soon as the key interest rate hits the lower limit of zero. In normal times, monetary policy control via nominal interest rates is very effective: As long as inflation expectations remain stable, lower nominal interest rates lower the real interest rate. Countercyclical interest rate management can stimulate economic activity in a recession and dampen it in a boom. The interest rate channel (to stimulate private investments, but also private consumption) and the exchange rate channel (the induced devaluation stimulates net exports) serve as transmission mechanisms. From the point of view of liberal economists, interest rate control is an ideal stabilization instrument - not least because it is distribution-neutral: it does not interfere with the mechanism of determining relative prices and thus leaves market forces free. The private actors are free to decide what kind of investments they want to make; no government guidelines stipulate in which sectors demand should be supported.
In the liquidity trap
In his General Theory, Keynes2 had already postulated the ineffectiveness of traditional monetary policy in a liquidity trap. He advocated using fiscal policy instead as an effective stabilization instrument under such conditions. For a long time, however, the liquidity trap argument was viewed only as a theoretical curiosity. It has almost no relevance to the real challenges of macroeconomic policy; there is also a lack of convincing microeconomic foundation. The experience with the lower limit of interest rates in Japan made it suddenly clear that this was a misjudgment.
The low interest rates there have long been viewed by many in public, and even in circles of the Japanese central bank, as an indication of an extremely expansionary policy that harbors high inflationary dangers. The central bank therefore deliberately emphasized again and again that it would raise interest rates again as soon as the inflation rate should rise even moderately. Milton Friedman, on the other hand, recognized that the low interest rates in no way pose a risk of inflation, but rather, in view of deflationary tendencies, should be interpreted as an indication of an overly restrictive monetary policy. Guided by his analysis of the undesirable developments in monetary policy during the Depression of the 1930s, he therefore pleaded for a change to the deliberate expansion of the monetary base (a policy of quantitative easing) in order to stabilize the monetary aggregates in the private sector.
Shortly after Friedman's remarks, the central bank of Japan actually switched between 2001 and 2006 to a policy with quantitative targets for expanding the monetary base. During this time, it expanded its balance sheet by around 75% - almost entirely through the purchase of government bonds. However, with the first signs of recovery, the expansion of the monetary base was quickly reversed in 2006. Despite the massive expansion of the monetary base, nominal GDP barely rose at all over the entire period.
The effectiveness of such a strategy is theoretically highly controversial. Keynes argued as early as 1936 that a mere expansion of the monetary base would have no real effects once the private sector is saturated with liquidity. Paul Krugman3 examined the core of the problem in a simple dynamic macro model: as soon as the lower limit of the interest rate is reached, the real interest rate can only fall if the central bank is prepared to let the price level rise in the future. This presupposes rising inflation expectations at least over a certain period of time. According to the Fisher equation, the real interest rate is the difference between the nominal interest rate and the expected inflation rate.
Conscious inflationary policy
If, on the other hand, it is not possible to stabilize falling inflation expectations, there is a risk of a deflationary spiral. Eggertsson and Krugman4 use a neo-Keynesian approach to provide a micro-economic foundation for the underlying mechanism. They model the vicious cycle between falling prices and the resulting increase in the real interest burden on debtors, which Irving Fisher5 identified as the central cause of the Great Depression in 1933. The pressure to rapidly reduce debt (deleveraging) triggers a decline in debtor demand. Creditors would only offset this decline if falling real interest rates made it more attractive to start consuming today. However, if real interest rates cannot be reduced, there will also be a drop in demand for the economy as a whole. It exacerbates the problem and threatens to trigger a deflationary process. A conscious policy of higher inflation rates could stop this fatal process.
The rise in the inflation rate has a redistributive effect between creditors and debtors. Under these conditions, however, this effect has advantages for everyone involved, because fixed contracts that are individually nominally agreed can be adjusted to changed macroeconomic conditions. Just like rigid wages and prices, nominal interest rates agreed in the past do not react to macroeconomic shocks. It does not seem rational for the individual lender to agree to an effective reduction in the interest burden. But all creditors would also be better off overall if a slight rise in inflation prevented the sharply rising real debt burden from driving the debtors into bankruptcy and thus causing production to collapse further.
However, a policy that announces that it will deliberately allow slightly rising inflation rates for a certain period of time faces the problem that such announcements are not credible. The easiest way to illustrate this is in the event that the reasonable real interest rate in the short term is negative - a plausible scenario during the deleveraging process when over-indebted households try to reduce their high levels of debt. Once the nominal interest rate remains at zero, the real interest rate can only fall if inflation expectations rise. The private actors would therefore have to be convinced that the central bank is prepared to tolerate a rise in the price level and not to reverse it later. However, once the economy has recovered from stagnation, the central bank's incentives change fundamentally. Then it will try to restore price stability and thus deviate from its original announcement. Anticipating this incentive, private actors doubt their willingness to allow higher inflation from the outset.
The fear that the stimulus will be prematurely reversed out of concern about the threat of inflation makes it impossible to lower the real interest rate right from the start - but that leaves the economy in stagnation. The central bank faces a dynamic consistency problem that is exactly the opposite of the traditional monetary policy consistency problem - the incentive to stimulate the economy with too much inflation. The fact that the Japanese central bank has rapidly reversed its monetary base is an impressive confirmation of these mechanisms.
In the liquidity trap, the world is practically turned upside down. Krugman6 provocatively stated that the central bank had to make a credible commitment to act “irresponsibly”. It is precisely this somewhat unfortunate formulation that may well be one of the reasons why central banks have not yet followed his advice. Ben Bernanke, 7 then a colleague of Krugman's at Princeton University, criticized the Japanese central bank just as heavily in 2002 as Milton Friedman. He outlined in detail various strategies of unconventional monetary policy that could prevent additional liquidity from being hoarded and thus remaining ineffective.
He showed, for example, that the provision of additional liquidity can have real effects if the central bank takes on risks that the private sector is not prepared to take. In a credit crunch where private markets are dysfunctional, buying out risky paper can help correct distorted market prices. The Fed's credit easing policy during the financial crisis followed precisely this strategy; it tried successfully to correct inefficiently high interest rate premiums through targeted interventions.
In his essay, however, Bernanke8 formulated much more far-reaching considerations - as the following quote shows, which later earned him the nickname “Helicopter Ben”: “The US government has a technology called the printing press (or, nowadays, the electronic equivalent of it), which allows you to print as many US dollars as you want at virtually no cost. If the amount of dollars in circulation increases (if only by the credible threat of doing so) the US government can reduce the value of a dollar in units of goods at will ... and thus ensure higher spending and positive inflation rates. ”9
Ben Bernanke is well aware of the effectiveness of higher inflation rates in a liquidity trap. So it was all the more surprising that, as head of the central bank in Washington, he has not followed his own advice, at least so far. On the contrary - in some respects the current policy of the US Federal Reserve seems to be almost a direct copy of the strategy of the Japanese central bank: The monthly statements of the Board of Governors of the Fed regularly promise a period of sustained low interest rates; at the same time, however, they always indicate that this phase would end quickly if the economy gained momentum. In addition, the Fed's concern about price stability is always monotonously emphasized: "With the aim of promoting the current economic recovery and helping to ensure that the inflation rate remains at a level over time that is compatible with the Fed's mandate, the panel decided today ... The panel discussed available instruments to promote a stronger economic recovery within the framework of price stability. ”10
When asked explicitly at a press conference in April 2012 about demands to raise the inflation target, Bernanke formulated: “From the point of view of the committee, that would be extremely rash. The Fed has spent 30 years building credibility for a policy of low and stable inflation rates. ... From my point of view, it would be extremely unwise to put this capital at risk for only very tentative and perhaps even dubious advantages in the real economy. ”11
Some (such as Laurence Ball12) see the reason for Bernanke's radical change from a sharp academic critic to the defender of a cautious stance in the psychological peer pressure that a decision-making body such as the Fed's board brings with it. However, two other reasons for the reluctance appear to be much more plausible: (1) on the one hand, the fact that unconventional monetary policy is almost inevitably politically controversial; Unfamiliar steps therefore go hand in hand with a polarization that makes it difficult to implement far-reaching changes;
(2) on the other hand, the fragility of expectations about future monetary policy.Without adequate binding mechanisms, it cannot be ruled out that even a very limited increase in the inflation rate will be interpreted as an entry into a “nuclear option” of permanently high inflation rates and thus the price trend threatens to get out of control.
- To (1): Unconventional monetary policy cannot be limited to a convenient laissez-faire approach; rather, it inevitably requires active intervention in the market mechanism. For example, propping up risky assets requires assessments of what market prices are skewed and to what extent they are. There is inevitably a controversial view of this. This threatens to make the central bank politically vulnerable in its actions - the separation between monetary and fiscal policy is becoming blurred. It would be naive to believe that under such conditions monetary policy can act in a distribution-neutral manner. From a macroeconomic point of view, it is certainly in the interest of the creditors to alleviate the real debt burden if this creates stable growth conditions. However, the question of how the adjustment burdens are distributed among those involved harbors violent conflicts of interest. Such controversies paralyze politics and prevent decisive steps. The paralysis resulting from such conflicts explains to a large extent why the recovery in financial crises after a sustained credit boom is much longer in coming than in times of normal recessions. It also explains why central banks have a hard time pushing through changes that could easily be misunderstood.
- To (2): A considerable part of the monetary policy effect unfolds through the expectation channel - through the influence on the expectations of private economic actors. The effectiveness depends essentially on your own credibility. Modern central bank policy consists to a large extent of communication strategy. If you turn away from familiar paths of action in the face of new challenges, there is a risk that expectations will suddenly turn in a completely different direction. The advantages of a targeted, time-limited increase in the inflation rate by a few percentage points can easily be outlined in theoretical models. In practice, however, such fine-tuning of expectations is only possible if one can fall back on credible binding mechanisms. Otherwise, there is a high risk that the actions will be misunderstood by the public. The discussion in Japan provides a good example of this: If low interest rates or a strong expansion of the monetary base are misinterpreted as an indication of an ultra-loose monetary policy, this enormously restricts the scope for an appropriate monetary policy.
Wait - a dangerous strategy
The paradox, however, is that a policy that is too cautious runs the risk of exacerbating the problems - the longer you wait, the longer the stagnation of the economy drags on; This makes the problem of over-indebtedness all the more serious. At some point there will come a time when a change to more inflation becomes inevitable, but then it will take place with all the more violent force. Ken Rogoff13 aptly puts it: “Many (if not necessarily all) central banks will ultimately figure out how to generate higher inflation expectations. They will have to tolerate higher inflation as a means of forcing real wealth investors to hasten deleveraging and as a mechanism that enables real wages and home prices to be revised downwards. It is nonsense to say that no matter how hard they try, central banks are powerless and completely unable to raise inflation expectations. In extreme cases, governments can appoint central bank governors who have long stood for their tolerance of moderate inflation - an exact parallel to the idea of using 'conservative' central bankers to combat high inflation. "
Ultimately, a wait-and-see strategy runs the risk of ending up in the worst of both worlds: first, the economy remains in a long period of stagnation; but then there is an even more dramatic overshoot exactly in the other direction. At this point, however, it is likely to be too late to achieve the desired effect. It would be all the more important to make a decisive move towards credible mechanisms that enable a rapid transition to higher growth with a narrow rise in inflation.
Scott Sumner14 has long propagated the strategy of managing nominal GDP as an ideal instrument for precisely this purpose. Recently, this idea has been gaining more and more supporters. An obligation to bring nominal GDP back on the trend path before the outbreak of the financial crisis is attractive as a communication strategy because it sends clear signals to the public. On the one hand, it makes it clear that politicians are ready to tolerate a short-term rise in inflation. On the other hand, a long-term anchor against which politics must be measured is clearly defined. In this way it could be possible to divert the public's attention away from ambiguous indicators (such as low interest rates or a massive expansion of the monetary base) towards a credible growth strategy.
- 1 M. Friedman: Keynote address to the Bank of Canada, http://www.bankofcanada.ca/wp-content/uploads/2010/08/keynote.pdf.
- 2 J. M. Keynes: The General Theory of Employment, Interest and Money, Cambridge 1936.
- 3 P. Krugman: It‘s Baaack: Japan‘s Slump and the Return of the Liquidity Trap, Brookings Papers on Economic Activity, vol. 29 (1998), pp. 137-206.
- 4 G. B. Eggertsson, P. Krugman: Debt, Deleveraging and the Liquidity Trap: A Fisher-Minsky-Koo Approach, in: The Quarterly Journal of Economics, 127th vol. (2012), no.3, pp. 1469-1513.
- 5 I. Fisher: The Debt-Deflation Theory of Great Depressions, in: Econometrica, 1. Jg. (1933), no. 4, pp. 337-357.
- 6 P. Krugman, loc. Cit.
- 7 B. Bernanke: Deflation: Making Sure "It" Doesn‘t Happen Here, National Economists Club, Washington DC, November 21, 2002.
- 8 Ibid.
- 9 Ibid.
- 10 Board of Governors of the Federal Reserve System: FOMC Statement, Press Releases, 2011/2012.
- 11 B. Appelbaum: Bernanke on What the Fed Can Do, in: New York Times, April 25, 2012.
- 12 L. Ball: Ben Bernanke and the Zero Bound, Working Paper, Johns Hopkins University, 2012.
- 13 K. Rogoff: How long will interest rates stay low ?, blog post 2012, Project Syndicat, http://www.project-syndicate.org/commentary/how-long-for-low-rates-by-kenneth- rogoff / german.
- 14 S. Sumner: Re-Targeting the Fed, in: National Affairs, 9th year (2011), pp. 79-96.
From high national debt and expansionary monetary policy to inflation?
Heiner Flassbeck, Friederike Spiecker
The ongoing crisis in the financial markets since 2008 has pushed the topic of inflation to the fore at the regulars' tables, despite the miserable economic development. Bank bailouts by the states, government bond purchases by the central banks, rescue packages worth billions for crisis countries and rising national debts all over the world are fueling the fear that politicians could choose a way out of the debt burden due to high inflation despite assurances to the contrary and debt brakes. Can she do that?
Of course, fiscal policy influences the prices of goods and services through the demand that it develops on the market itself. However, if the state withdraws income from private individuals through taxation, it largely compensates for lost private demand. If the state provides households with financial resources through redistribution, aggregate demand only increases to the extent that the savings rate of the beneficiaries is lower than that of the payers. Public demand financed by borrowing increases the total demand directly if displacement effects on the capital market can be ruled out, which is usually the case. But here, too, an increase in public demand only has a price-driving effect if capacities are largely utilized. There can be no talk of this in the whole world at the moment. Speculative price increases in real estate, precious metals, food or oil have nothing to do with increased public consumption. Even if high national debts should lead to tax increases at some point, this will not lead to inflation, because such tax increases can only trigger a one-off boost in prices.
The best example of the fact that it is not so easy for a state to ignite a noticeable rise in prices, even though it has tried to do so and has become extremely indebted, is Japan. For two decades, the country has been struggling with a deflationary development that is massively damaging its real economy and cannot escape it
Expansive Monetary Policy?
But aren't the central banks preparing the inflation of the day after tomorrow or even the next crisis with their low interest rate policy and extensive direct and indirect government bond purchases? Wasn't the 2008 financial crisis preceded by an excessively expansionary monetary policy by the Fed? 2 Monetary policy can only indirectly influence the inflation rate and only via the “detour” of the real economy. The central bank only has a direct influence on the inflation rate through a “money jacket” tailored to the real economy, however narrowly or widely, in the fictional world of the monetarist “quantity equation”, which is an identity and therefore does not allow any causal statement
The actual interdependency is based on the interplay of short-term and long-term interest rates on the one hand and on the relationship between the level of interest rates and capital investments on the other. A high level of interest rates makes loans more expensive and tends to dampen investment in property. Capacity utilization in the capital goods sector is falling, which is gradually being reflected in slower growth or even in a decline in overall demand. That slows down the overall economic price increase. In large, relatively closed economies, the central bank is able to do this at any time in large, relatively closed economies, to raise short-term interest rates, thereby channeling the level of long-term interest upwards and thus putting a stop to an undesirable acceleration in inflation. The price for this are losses in the real economy in the form of unemployment and declines in real income.
In the case of a real economy slipping into recession and a consequently too low or even negative rate of price increase, however, the possibilities of monetary policy are limited. Monetary policy can try to stimulate investment demand through low short-term interest rates. However, it can only do this if banks and other financial investors have confidence in the creditworthiness of potential property investors and if there is even a decline in the utilization of existing capacities. If the income expectations of private households as the most important end customers are generally subdued, the entire real economy can find itself in a situation in which additional and cheaply made available money does not induce any new demand in the market. Then the effect of monetary policy tends to zero.
And it is precisely with this scenario that the global economy is currently struggling. High unemployment in the wake of the financial crisis is depressing wages and thus income expectations in all industrialized countries, without unemployment itself being the consequence of excessively high wages. On the contrary: in the run-up to this recession, worldwide wage increases fell short of the scope for distribution (trend productivity growth plus inflation target), and yet unemployment rose. The result is extremely weak consumer demand and investment activity
Deregulated financial sector
Indeed, before the crisis, a deregulated financial sector had opened the door to financial speculative transactions with a private-sector zero-sum and macroeconomic negative-sum character and interrupted the transmission mechanism of monetary policy.5 Money flowed primarily into speculation-sensitive assets rather than into productive real economic activities. The resulting price bubbles ate their way into the "normal" price index - e.g. for heating costs, food prices and rents - which monetary policy was only able to combat with interest rate hikes. However, this primarily affected property investors, the real economy and workers, while the players in the financial markets were rescued to a large extent by the state.
Because there has been no real re-regulation of the financial system, the real economy is still down, but speculation in real estate, raw materials and currencies has regained its old "strength" and again caused assets and prices to rise, some of them on the work through the general price index and cause confusion among inflation observers.6 However, it is not the central banks and their crisis policy that are the addressees for these problems, but rather the policy that is apparently unable to ensure that the monetary and credit system is back on track actual tasks and only performs these 7
The failure of the politicians is not only due to successful lobbying by the financial world and a lack of international cooperation in economic policy. Above all, it has to do with the prevailing understanding of how a market economy works. “Saving” is still uncritically viewed as a prerequisite for investing. Capital flows to developing countries, for example, are considered unreservedly good, regardless of the purpose for which they are used. With such a view it is impossible to distinguish in advance between the unhindered flow of savings capital into socially profitable tangible assets and the harmful excesses of misguided financial speculation as an "investment".
Quite different if savings are not viewed as a necessary source of investment activity, but rather as an obstacle to investment due to a reduction in capacity utilization. Then one can and must fully ensure that the monetary and credit system is only available for two things: for the liquidity supply of the normal business operations of the real economy and for credits created through money creation, with which real macroeconomic growth is financed in the form of additional tangible investments 8 The best way to force loans “out of nowhere” into this use is to return to the segregated banking system with prohibitively high capital requirements for speculative financial transactions and the requirement that banks that grant loans must keep them as receivables on their books and are not allowed to resell, because only then will they have the necessary interest in the selection and control of the projects of their debtors. Such a world, combined with loans “out of nowhere”, includes low real interest rates. Because they enable economic dynamism that leads to real income growth from which everyone benefits, including savers. Interest can only be paid from real growth, which is not based on hot air, but actually on goods.
In a competitively organized market economy with financial markets regulated in this way, the prices for goods and services primarily reflect the production costs. Since wage costs are by far the most important costs for the economy as a whole, the macroeconomic inflation rate depends to a large extent on the development of unit labor costs, i.e. on wage growth in relation to productivity growth. Prices are determined neither by the central bank nor by fiscal policy and consequently the rate of change in the overall economic price level, contrary to what many believe or fear, is not directly in the hands of fiscal and monetary policy.
Risk of deflation
Because in EMU all fiscal and labor market policy efforts to bring the competitiveness of the EMU countries into line with deflation, the USA is very close to a deflationary development and Japan still shows open deflation, there is and especially in the globalized economy in Europe there is no risk of inflation at present or in the foreseeable future, but a dangerous risk of deflation.
Because of the asymmetry of the possible effects of monetary policy as described, it is necessary to counter this with a direct income policy9 and possibly with an expansive financial policy. But from the fear of hyperinflation cultivated in the media in Germany and the flat and false belief that “more” money always fuels inflation, many politicians, who are squinting at the majority of the electorate, refuse to finally abandon the counterproductive savings therapy when fighting the euro crisis .
It is simply easier to win over the regulars' tables with catchy explanatory models based on microeconomic thinking than to learn new things through impartial thought and to commit to public education in matters of macroeconomics. The price for this short-sighted attitude will be very high and will again have to be paid primarily by the lower income earners.
- 1 See R. C. Koo: The Holy Grail of Macroeconomics: Lessons from Japan‘s Great Recession, New York 2008.
- 2 See H. Flassbeck, F.Spiecker: It wasn't Greenspan's monetary policy, in: Wirtschaftsdienst, 88th year (2008), no. 12, pp. 805-809.
- 3 Cf. H. Flassbeck, F. Spiecker: The End of Mass Unemployment, Frankfurt a.M. 2007, pp. 165 ff.
- 4 See UNCTAD: Trade and Development Report 2012.
- 5 Cf. F. Spiecker: Bankengeld oder Zentralbankgeld ?, in: FTD Wirtschaftswunder from April 29, 2009; http://wirtschaftswunder.ftd.de/2009/04/26/friederike-spiecker-bankengeld-oder-zentralbankgeld/ (3.9.2012).
- 6 See UNCTAD: Price Formation in Financialized Commodity Markets: The Role of Information, New York, June 2011.
- 7 Cf. F. Spiecker: Debt, but correct, in: Le Monde diplomatique, June 2009, p. 8.
- 8 See H. Flassbeck, F. Spiecker: Das Ende der ..., loc. Cit., P. 233 ff.
- 9 UNCTAD proposes in its Trade and Development Report 2012 that governments set wage guidelines and / or send signals to the collective bargaining partners through the dynamics of the minimum wage development they set.
Tax justice as an investment in the future
Stefan Bach, Gert G. Wagner
In order to reduce the national debt, which in Germany now amounts to a good 80% of the gross domestic product (GDP), a combination of growth and savings in government spending is usually recommended in large parts of the public and politicians. The obvious alternative, namely tax increases, has not been seriously discussed for almost 20 years. Although targeted tax hikes to repay government debt are also a way of reducing debt through higher inflation. This alternative is practically not even discussed in Germany, although inflation is the “classic” instrument for public debt relief. But hyperinflation and currency reforms after the two lost world wars are a national trauma in Germany. The high level of price stability of the last few decades by international comparison is still worth striving for in Germany
The disadvantages and advantages of increased inflation in the euro area are discussed in detail in the other contributions to this discussion.2 This contribution is only briefly discussed in this article. Instead of inflation with unclear distributional effects and economic consequences, the possibilities are presented here to reduce public debt in an orderly and socially balanced manner with targeted tax increases. The possibilities of increasing income, inheritance and property taxes are only briefly discussed, but more intensely on the reintroduction of a wealth tax and, above all, on the possibilities and limits of a one-off property tax, as it was levied as part of the burden sharing after the Second World War .
Lower spending is not a silver bullet
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