In a recent post Scott Sumner says the pro-German ECB is a myth:
The ECB likes low inflation. So does Germany. That has led many people to wrongly assume that ECB policy is somehow pro-German.
I recall attending a European economics conference about 6 or 7 years ago, and hearing German academics complain that ECB policy was appropriate for high-flyers like Spain and Ireland, but too tight for Germany. At that time Spain and Ireland had relatively high inflation (Balassa-Samuelson effect), and since the ECB was targeting average inflation, this meant slow-growers like Germany suffered from an excessively tight policy.
As the figure shows, Spanish inflation has been higher than the EZ average, but German inflation has mostly been very close to the average since 2004, so it doesn´t appear that “slow-growers like Germany suffered from an excessively tight policy”.
The panel below indicates that, with the exception of Italy, ECB policy kept countries NGDP growing very close to their trend path (estimated from 1995 to 2005). But notice that after the labor market reforms of 2002-04 (that resulted in “wage moderation”) Germany´s NGDP “shoots up”.
The next panel shows that ECB policy begins to tighten at that very moment. As the inflation chart above show, inflation came down everywhere. But in mid 2007 the oil and commodity price shocks happened. The ECB had already ended its “tightening cycle” but in July 2008 decided that more tightening was called for! An error that may have helped nourish expectations of falling incomes at the same time that monetary policy errors in the US were about to unleash the “Great Recession”. Soon after it had to reverse direction.
Scott puts up a chart comparing German and US unemployment. But the right comparison is between German and Eurozone unemployment. The chart below shows that except during 2003-07 German unemployment was below the EZ rate, falling fast after the labor market reforms of 2002-04 took effect, continuing to fall after the crisis.
I pushed back politely. Look, I said, it’s not Greece I’m worried about. It’s Italy. Third-biggest bond market in the world. Bond spreads this morning again heading over 7% (before the ECB intervened this to push them back down again.) Too big to fail, too big to save. Is the government, even one under a new Prime Minister, going to push through sufficient austerity to avoid a default?
Now the consultant perked up, speaking what he too believes to be the unvarnished truth. They have to, he said, because “to be blunt about it, we have them [both the Greeks and the Italians] by the balls.”
And make no mistake – that, in essence, is where the European crisis stands. The Germans — and the ECB along with them — believe (perhaps hope is the better word) that two new technocratic prime ministers, former EU commissioner Mario Monti in Italy and MIT-trained economist Lucas Papademos in Greece, will cast politics aside and force angry populations in both countries to take their medicine, whether they like it or not. Because it’s for their own good, you understand. And besides, “we have them by the balls. They have to do what we say.”