Germans preach

Michael Heise, Chief-Economist of German insurance giant Allianz writes in the Financial Times: “Quantitative easing would sow the seeds of crisis not recovery”. According to him (a German “representative ‘brainwashed’ agent”):

The fear of a descent into Japanese-style deflation is starting to influence monetary policy making in the eurozone.

Inflation in the currency union continues to creep downwards, standing at 0.3 per cent in August. The European Central Bank is contemplating whether to follow the central banks of the US, the UK and Japan in implementing a programme of quantitative easing, buying assets in large quantities.

But such a strategy would not prevent a Japanese-style “lost decade”. It may in fact lead to the very predicament it aims to avoid.

There are several reasons why the ECB should not go down the route of QE:

First, the recent low inflation rates are in part a result of the decline in oil and other commodity prices. They also reflect necessary adjustments in the eurozone periphery…There is no sign of a vicious circle of falling inflation expectations and consumer restraint. Inflation rates will gradually climb again as the economy recovers(!). They also reflect necessary adjustments in the eurozone periphery – wage moderation and the impact of structural reforms are feeding through into lower prices across the board, which is exactly what countries such as Greece and Portugal need to restore competitiveness and bolster purchasing power.

Second, although the ECB has several options when it comes to implementing QE, there are serious objections to all of them. Buying asset-backed securities or corporate bonds would expose the European taxpayer to credit risk…

Third, the impact of further (!) monetary easing on output and price levels would be negligible. That is because the recession in many parts of the eurozone is caused by the hobbling effect of the unsustainable amounts of debt that were built up by public and private actors during the boom years. Over-indebted households and companies are unlikely to pile up more debt; on the contrary, they are trying to pay it down. This makes monetary policy ineffective.

Fourth, the collateral damage from ultra-loose(!) monetary policy is accumulating. Risks to financial stability are growing as investors are piling into riskier assets in search of higher returns. Already, some assets such as junk bonds are trading at what look like inflated prices.

Fifth, further monetary easing would delay the much-needed adjustments in the balance sheets of European banks and companies. An abundance of cost-free liquidity from the central bank enables commercial lenders to continue propping up weak creditors.

History be damned! Even Japan´s QE light of 2002-06 had some effect. What about present day US and UK? And present day Japan?

Low/falling inflation the result of falling commodity and oil prices? The data don´t agree. In the charts inflation has been falling since Trichet´s monetary policy screw-up in 2011, when rates were raised twice (April and July). If anything, oil and commodity prices have been pretty stable for the last three years! But the periphery needs internal devaluation anyway!

Germans Opine_1

Germans Opine_2

The cause of the recession is not the “unsustainable amount of debt”, but the dramatic fall in nominal spending (NGDP) as the chart below illustrates clearly.

Germans Opine_3

How can monetary policy be “ultra-loose” if NGDP is so far “off-track”?

Germans Opine_4

Germany beware! You´ll likelyend up sinking with the “Euro-ship”!

One thought on “Germans preach

  1. At least we agree on one thing, the goal of price stability is rather meaningless. They say so themselves in the first point. Inflation targeting is dead, killed by the zealots themselves. They just have to find out the hard way that nothing escapes the vortex of monetary deflation. It’s so sad because it just doesn’t have to be that way.

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