Speaking up for the Euro Area

A James Alexander post

Our fellow Market Monetarists seem to be struggling a bit with making sense of the enormity of the post-Brexit market moves. It’s actually a curse sometimes being a Market Monetarist and having to take wild market moves seriously, or having to interpret them. NGDP Futures markets make sense, little else does.

Sure, the swing from 90/10 probability for Remain at 10pm on the 23rd to 0/100 certainty of Leave two hours later was pretty extreme. The huge swings in markets on the news could be seen as the “pure” reaction to the news, but then again what were markets actually pricing from one moment to the next. All sorts of stuff.

And once you start trying to analyse market moves in the following days you start to open the Pandora’s box of analysing thousands of things. And you actually then have to start looking at movements prior to the Brexit news, or anticipation of that news, and all the other thousands of things that influence market movements.

The Brexit issue has been hanging around the UK, Europe and the world for many, many years. The future of the EU and the Euro Area, likewise. It is tangled up with geo-politics: the Russia question, the breakdown of the Middle East, relations with Turkey. Is the EU a superpower? Is it the EU vs the US. Is it the G7 vs the RoW? Brexit throws all these things up in the air, and thousands more. Ask any International Relations undergrad.

One part of the jigsaw is Euro Area monetary policy. Scott Sumner today tries to make sense of all the market movements and says, without irony:

“the rest of Europe needs to take this very seriously.  Right now, almost no plausible amount of monetary stimulus from the ECB would be excessive.  It’s pedal to the metal time.”

Of course the rest of Europe needs to take this very seriously, very seriously indeed. Does he suppose it isn’t? There are lots of issues to consider, thousands, in fact. Sure the EU and the ECB are dysfunctional, but tell us something new. Is it more or less dysfunctional than the US at the moment? Maybe, maybe not.

Sumner appears to have slightly lost the plot when he talks of monetary stimulus. There are some facts out there already. The ECB is undertaking huge monetary stimulus already if he means QE or negative rates. Currently, the Euro Area is seeing 40%+ YoY Base Money growthThe ECB is committed to its current and recently expanded programme for at least 18 months. Target interest rates are solidly below zero.

What Sumner may mean is changing the targets, rather than ever bigger tools. If he does mean that, then he should say it. We have been arguing here for months that the ECB should either raise its inflation ceiling or far better, switch to NGDP level targeting.

Strangely, things aren’t too bad on the NGDP growth as we have documented.  As the chart indicates, as the US began tightening monetary policy in mid-2014 through the “rate hike talk”, we see US NGDP growth trending down. The opposite is observed in the EZ countries.


The stimulus is working slowly, but could work so much better if the targets were changed.

Draghi gives a Monetary Economics 101 class

A James Alexander post

ECB President Draghi was on far better form in his press conference after the April ECB Council meeting  than the one in March.

It was great to hear the German journalists having the special pleading of their insurance companies, pension funds and savers slapped down time and time again by Draghi. They are only one country in the Eurozone, like it or lump it. The ECB sets policy for the whole monetary area.

German leaders and economists also do those special interests a massive disservice by not helping them to understand the direction of causality when it comes to monetary policy. Low rates are a sign of tight money, not loose, or ultra-loose as so many supposedly clever commentators like to mistakenly opine. High rates are a sign of loose policy.

In a splendidly clear answer to one journalist, about 38 minutes in, Draghi stated:

Low interest rates are a symptom of low growth and low inflation. It’s not the monetary policy consequence … as I’ve said before, if we want to return to higher interest rates we have to return to higher growth and higher inflation to do so we need the current monetary policy, that’s the necessary condition [for a recovery].

Hear, hear!

Euro Base Money continuing to grow to US$ levels, Helpful….

A James Alexander post

I remain a bit disappointed that Euro Area QE and negative rates are not proving more of a hit with the markets and thus the economy. But are things really as bad as painted by our friend Lars Christensen?

It is hard to know exactly what is the best measure to use to gauge the subdued market expectations. Euro Area equities should be a useful guide and have most certainly been very dull but are dominated by utilities and quasi-utilities like banks. Most of the best German companies are privately owned, the same in Italy.

European government bond markets are a horror show when it comes to prospective growth expectations, especially nominal growth – even  many years out. German Government 10 year benchmark bonds are flirting with going negative, following Switzerland and Japan.

The Euro currency itself stopped falling many months ago, a sign of lack of easing but has been in a  relatively tight trading range as we discussed last week.

Perhaps we are too impatient, but we are also Market Monetarists so we pay attention to what the market expects to happen – and believe it is by far the best guess as to what will happen. Still, it seems to me that the power of the ECB’s QE is being overlooked. Sure the ECB is way behind the curve versus the Fed’s earlier bouts of QE.  But the plan is clear, over the next one and half years of bond buying at €80bn per month it will overtake US levels of QE – assuming the Fed keeps its stock of bonds flat. And the growth rate of base money will continue to be way better than the US.

For Market Monetarists the biggest benefit from QE and other “instruments” is the signalling effect, just how committed a central bank is to its targets. And the ECB is clearly signalling its intent with  QE.

Unfortunately no amount of firepower will be of any use if it is aimed at the wrong target. 2% inflation is the wrong target.  A level target for nominal growth is far superior. A level target for prices  is not so bad nor is a properly communicated flexible price inflation target, its close relation. The ECB does not use these targets but insists on a very strict inflation ceiling of “close to but not above 2%”. Just as the Fed will struggle to live down its December 2015 rate rise, so the ECB is still struggling to shake off a market view that it would repeat the 2008 and 2011 rate rise mistakes at the drop of a hat, or rather an approach towards 2% by its own inflation forecasts.

HICP inflation is maybe 2% or more above real inflation, so the ECB’s HICP target of below 2% growth in this measure is already a deflationary stance. So it’s a tough call. The ECB is using massive firepower and remains highly committed to using it, but for a purpose that is not convincing. It’s like driving flat out fast towards a destination that  isn’t where you should want to go, and whenever you get close to it you promise to apply the brakes.

The Japanese central bank is apparently so fed up with its inability to hit its CPI target despite  QE that  at the end of the month  it is rumoured they may switch to NGDP Targeting. Sure it could even keep its 2% inflation target but subject it to a test of 4-5% NGDP growth being met first. The ECB could do the same. It isn’t meeting its target of price stability so it needs to look at redefining it.

Market expectations will do the rest of the job once freed of the fear of monetary tightening any time projections for HICP or CPI or even PCE PI begins to approach 2%.


Draghi; the pedal to the metal is fine but he needs to get out of first gear

A James Alexander post

Mr Draghi is like a car driver who has his foot pressed down hard on the accelerator (the instruments, QE, -ve rates, TLRTO, etc, etc) but hasn’t taken the car out of first gear, or maybe second (the inflation ceiling).

The measures announced today were all in line or better than expected in terms of instruments. and the markets liked it. He had managed to surpass already high expectations.

But, dear oh dear, he messed up when talking about the future. ‘No more rate cuts until the facts change’. The trouble is the facts NOW are not so great. Ruling out further easing unless the facts change is not what the market wanted to hear. If the facts stay the same, more action will be needed.

His aides rushed him a mid-meeting restatement of his position, but it just sowed more confusion. “The facts” seemed to transmogrify into the ECBs expectations of future facts, i.e. their forecasts not playing out as expected. So no big change, maybe.

That said, I was already well disappointed before the markets turned tail, they might have done so even without the confusing guidance given in the Q&A.

I like to monitor how soon in each press conference statement he raises the dead hand of the inflation ceiling, and it was a recent record – in the second paragraph came the reiteration of the ECB’s epitaph: “close to, but below, 2%”. Even worse was to follow, he reiterated it a second time in his official statement. It was that bad.

For the first time in a while one of the journalists managed a decent question rather than just asking incredibly dull stuff on technical details. A French guy asked whether the inflation target was symmetrical. Draghi froze, recovered himself, and said that it was. I think. Though others thought not. Who really knows. And then he froze again, looking physically sick. He didn’t elaborate and none of the other useless bunch of journalists in the room asked for more.

He seems scared of discussing what he calls the inflation target/mandate/epitaph of “close to, but below 2%”.

It’s hard to know why it is such an untouchable area. Is he really frightened that it might suddenly un-anchor inflation expectations and lead to hyperinflation? Is he worried about the reaction of Europe’s unelected (by Europe) “leader”, Mrs Merkel? She is powerful, witness the mass migration she triggered when making refugee policy for Europe on the hoof.

Anyway, while Draghi refuses to change to a higher gear, the car will move incredibly slowly despite wasting immense amounts of fuel with the accelerator pressed down to the metal.

This conclusion:

“We are reaching the limits of monetary policy, and that is causing markets a headache,” said Mark Dowding, senior portfolio manager at BlueBay Asset Management.

Is plain wrong. The markets reversal between Draghi´s announcement and the press conference is the clearest example of the power of monetary policy, for good or evil!

Euro Area grows as fast as the US

A James Alexander post

Despite all the pessimism the Euro Area nearly caught up with US NGDP growth in Q4. Now that Italy and Spain have finally reported their Nominal GDP figures Eurostat shows that 4Q15 NGDP growth for the Euro monetary region as a whole was almost as fast, year-on-year, as the US. Figures released today show that growth was 2.9% YoY in 4Q15 just behind the US at 3.0%. The 4Q15 out-turn was stable versus 3Q15. A still respectable figure and sadly in line with a long run average that includes the disastrous double-dip recessions of 2008 and 2011.

For the Euro Area to do as well as the US is good in one sense, but tragic in another as the US itself is doing so poorly relative to what it should be doing. Still, we would expect the Euro Area to pull away from the US given a high rate of growth in Euro Area base money versus no growth in the US, and an easing stance to monetary policy versus a haphazard but generally tightening bias in the US.

The weakness of the GDP deflator in the Euro Area relative to the US actually means NGDP growth was higher in the US than in the Euro Area, but only just. Market Monetarists don’t pay too much attention to the flawed RGDP concept (or its ugly sibling, the GDP deflator) but we know that others do. We are not convinced that the deflator in the US correctly measures inflation due to only small quality adjustments, thus overestimating it; and we are even less sure about that used in the Euro Area, where far fewer quality adjustments are made, thus severely overestimating inflation.

JA EZ Growth_1

JA EZ Growth_2

Our longer run trend line for the Euro Area shows just how much has been lost by the ECB-inspired double-dip recession.

JA EZ Growth_3

The biggest three countries, Germany, France and Italy all slowed a little, particularly Italy.  This is bad news for Italy as it really needs to see higher nominal growth to help grow out of its acute banking industry bad debt problems. Unless it leaves the Euro Italy will have to undertake a major bad debt clean up. And this clean-up must not cost the government so much money that the government then has also to undertake further austerity and exacerbate the bad debt problem. It is a tense situation. Greece redux? I hope not.

Italy is certainly not helped much by an ECB still stuck with its hopeless inflation ceiling targeting regime, that so undermines QE and other measures. New thinking, new targets are desperately required at the ECB. Italy, of all countries should see the need to move from inflation-ceiling targe to NGDP level growth targets.

Instead, all we see from its Prime Minister is posturing. Renzi needs to break free of his all-Too-Eurocratic advisers, kowtowing to the Germans in the comfort of their Brussels sinecures. He needs to push his compatriots to think about altering the ECB targets. Stable NGDP growth (at a higher level trend than at present) should appeal to all, both Italians and Germans alike.

Spain has largely addressed its banking bad debt problems and undertaken painful austerity and repricing of its domestic economy. The cost is still very high in terms of unemployment, but from its horribly low base NGDP has continued to accelerate, hitting 4.25% in 4Q.

Portugal showed a good improvement too. Netherlands was the standout disappointment, possibly because of the energy and other trades related to its important entrepot status.

The six-weekly ECB meeting is on Thursday. Expectations are quite high that Draghi will introduce further measures, especially a drop in rates to even more negative levels and maybe more QE.

Lower rates are better than doing nothing, but relatively ineffective compared to even a discussion of raising the inflation target or, far better, introducing or at least monitoring NGDP growth. Draghi disappointed markets badly in December, but his track record on surprising positively, when he has to, is good.

Prior to that December meeting the big guns on the ECB board from Germany made some seemingly hawk’ish comments. They have been quiet this time around, possibly due to German RGDP growth, NGDP growth, inflation, long term bond yields and business outlook all weakening. Germany needs faster growth, particularly to offset the political pressures on Mrs Merkel. What is good for Germany is not usually so for the Euro Area. This time around it should be positive. Awfully selfish, awfully true.

European NGDP shaping up to be dull, but not down

A James Alexander post

Market Monetarists like to look at expectations for NGDP growth, but also need historic data. The paradox of Euro Area market turbulence in spite of strong QE and historically recovering NGDP growth is a puzzle, perhaps 4Q15 NGDP is setting a poor trend like in the US and the UK ?

The Euro Area may have a single market and a single currency but it has a single statistics authority in name only. GDP figures are produced by Euro Area countries first and only collated by the EuroStat.

France and Germany are pretty efficient, releasing quarterly RGDP and NGDP figures almost as soon as the US and UK. Italy only reports RGDP figures on a first estimate, not a NGDP number. The fourth biggest Euro Area country, Spain, produces neither total until 9 weeks after the close of the quarter – although it does produce an estimated growth rate.

EuroStat do manage to produce an estimated RGDP for the monetary zone as a whole and this showed a YoY slowdown in growth from 1.6% in 3Q15 to 1.5% in 4Q15, principally because of a sharp drop in German RGDP growth.

This unsatisfactory situation means we have to look at individual countries for the more important NGDP trends. We were mildly encouraged by 3Q15 trends for the big two countries and remain sanguine after 4Q15. Germany slowed a little, but stayed well above its (low) long term average. France stayed at its very moderate pace, and somewhat below its long term average. These long-term averages obviously mask the disastrous “lost growth” period of the Euro Area recessions.

JA NGDP Germ-Fra With just over 60% of the Euro Area reporting NGDP data it looks as though growth will slow a touch. It is all depressingly low but not yet disastrous – on a look back basis.

And there is the rub. Market Monetarism argues market expectations of NGDP growth should be targeted. Markets are not indicating a great outlook if you look at the Euro currency, Euro bond yields or Euro equity markets. This appears to be a paradox given the large QE being undertaken by the ECB and the resulting strong growth in Euro base money.

We are confident that the QE is far better than not doing it, but it is slow and hesitant in its effect. One huge reason for this has to be the inflation ceiling of the ECB. This doleful target has to be repeated by President Draghi at every public engagement and every time it depresses the spirits: “close to, but not above, 2%”. It could yet be the Euro’s epitaph.

Did Draghi hint in the Q&A at his quarterly testimony to the European Parliament today, in response to a mangled question about money, that the ECB had been looking at alternatives to inflation targeting? Or additional tools? Perhaps. He ran out of time but seemed keen to elaborate. We hope so. It is a real shame no Parliamentarians took him up on the recommendation of one of their own reports strongly endorsing NGDP Targeting.

The German RGDP and NGDP growth being at the long term average also means their national interests dictate that they are happy with the current stance of monetary policy – and Germany is 30% of Euro Area GDP. And their influence in the ECB is even bigger as many smaller countries follow their lead. The markets know this too and adjust their monetary expectations accordingly.

Another reason why the growth may not be so helpful is that the ECB has a lot of ground to make up on the US. Base money growth may be flat or even shrinking in the US, but it has been much stronger in the past. The ECB is still way behind the US in terms of base money creation, so patience is also required.

The US had to cope with the headwinds of Trichet’s Euro Area double dip recession, and it may be that the Euro Area now has to cope with a US (sort of double-dip) recession. How the wheel turns! Either way, tight US monetary policy is a big headwind for the Euro Area in addition to its own domestically produced headwinds.


A major domestically produced headwind is the Euro Area’s banking sector. While the US banks equity index is 20% off its mid-2015 highs, the European banks index was down 40% from those highs.

Credit spreads have also blown out too. Partly it is because all the biggest banks in Europe are universal banks, like Citi, and heavily weighted to investment banking which gets hit hard by market turmoil. More retail-oriented banks are down less, as in the US. Except for Italy, where most banks are retail-oriented but in something of a crisis. Bank contagion, like sovereign contagion is a very bad thing. And markets clearly fear it. Ironically, the cause of the current bank pain is partly related to the global efforts to make banks safer by not only making them hold much more equity, but also much more junior debt too. The huge issuance of junior debt over the last couple of years is now trading at very low levels, and in Italy half is reportedly held by retail investors – never a good thing.

All that said, there should be no repeat of the bank liquidity crises at European banks thanks to the ECB backstops all being properly in place, unlike in 2011. However, it doesn’t help that the Netherlands Finance Minister and chair of the informal group of European finance ministers, Dijsselbloem, is a rather typical blunt Dutchman who in trying to restore confidence in the sector also encouraged fear by emphasising there would be no taxpayer bail outs again. There will be taxpayer bailouts if the taxpayers’ representatives like Dijsselbloem do nothing to order the ECB to change its targets.

The Fed is more like the ECB 2011 than Fed 1937

A James Alexander post

Ja-net Yel-len, Ja-net Yel-len, are you Tri-chet in dis-guise?

At football matches in England there is always a particularly hurtful chant that goes up around the ground when a team, a player or a referee is doing badly. They are very often compared to some team or referee or player whom everyone knows is far worse. It is sung to the tune of a famous hymn, like many football songs, “Guide me, O thou great redeemer”. Janet Yellen’s record so far as Chairman of the Fed reminds of this chant, and particularly Jean-Claude Trichet’s penultimate year (mis)guiding the ECB.

13th July 2011 should go down as a day of infamy in the Euro Area. It was date of the second rate rise by the ECB that year, that tanked markets and led more or less directly to a dramatic liquidity squeeze for Euro Area banks, and caused the plunge into the second part of the Area’s double dip recession.


We all now know that Euro Area troubles started in 2008 when the world was plunged into the Great Recession by pro-cyclical monetary tightening by various central banks, just as NGDP growth expectations were falling rapidly at the time of the Lehman default. A lot of other stuff was going on, for sure, but it was noise compared to the core monetary story.

The US and Europe had already spent two hard years escaping from the consequences of the 2008 tightening. Then, in an attempt to out-macho the US and impress the selfish German establishment, the ECB under Trichet decided to stamp on headline inflation hitting nearly 3% in early 2011, while core remained solidly below 2%. The ECB therefore directly smashed the early stages of recovery with a heavy tightening bias and two rate rises. The different paths of the two big currency blocs has been very well documented here with a good summary here.

Trichet and those two ECB 2011 rate rises

The first of the rate rises that year on 3th April 2011 did not cause undue damage. 1Q11 Euro Area NGDP had almost hit the dizzying 3.9% YoY. Within the Area German NGDP was at 6.4% YoY that quarter. This was too strong for Germany and so they pressed for a tightening and Trichet was only too happy to oblige, forgetting about the rest of the Euro Area, especially the periphery. In that quarter Spain and Portugal were already enduring marginally negative NGDP growth. Yes, they were in outright deflation but had their monetary policy tightened substantially – it seems really crazy the more you think about it. Greece had very negative NGDP YoY at -9%.

Never mind, the selfish, almost anti-European, old DM/German bloc anti-growth bias had to be appeased. Actually, it was even worse, Trichet was actually rather fanatical in thinking he was doing the right thing for the Euro Area as a whole. It was his final goodbye press conference that made me rethink my priors. He was forced to defend what havoc he’d caused by trying to claim credit for giving the Euro Area a lower inflation rate than Germany had experienced prior to the Euro – and hang the consequences of a double dip recession. It was all deeply personal and subjective. Central bankers can do no wrong and certainly cannot take criticism.

Well, the rest is history. The Euro Area slowed during 2Q11, as you’d expect from such a tightening of monetary policy. Although the Euro Area stock markets merely drifted, NGDP growth fell to 2.9%. The stock market drift may have lulled Trichet and his ECB into a false sense of confidence.

As expectations for NGDP growth dropped further, they made their second fateful move. Stocks tanked within days, the banking crisis re-erupted, engulfing the French bank SocGen in particular. NGDP fell to 2.4% during 3Q and carried out on down. It was too late, the damage had been done and the cycle was hard to turn.

Market response to April 2011 ECB rate similar to December 2015 Fed rise

We often see articles and blogs wondering whether the US rate rise in late 2015 will end up forcing the country to re-live the great 1937 stumble in the recovery from the Great Depression when monetary policy was tightened too early. The Euro Area from 2011 seems far more apt, and fresh in our memories. A slow recovery, with a few hot spots, was stamped on by two rate rises amidst a severe tightening bias. Rates ended up falling, of course. The first rate rise was seen by the markets as almost manageable, or rather it was met with a degree of sang froid. The second seemed mad given where NGDP expectations had tumbled.

The December 2015 rate rise seemed to be met with a similar sang froid, after all it had been expected for months. Some, particularly market Monetarists, had warned of the dangers of the monetary tightening and thought actual and expected NGDP growth too weak to cope. The market sang froid was probably mistaken by the Fed as an acceptance that its full-blown “normalisation” programme could proceed as they planned. Vice-Chairman Stanley Fischer’s now notorious 6th January interview on CNBC, especially his articulation that four more rate rises this year was “in the ballpark”.

Economic news has been poor since then, reflecting the impact of the 2015 monetary tightening, and now expectations are falling. The question remains: Is Janet Yellen Jean-Claude Trichet in disguise? Will she take some market tranquillity as a justification for a second rate rise? Maybe. Just how much does she fear inflation rising to the Fed’s forecast of 2%, how stubborn will she be in pursuing her “normalisation” programme come what may?

“You don’t know what you’re doing”

When the team, referee or player continue to invite really bad comparisons the football fans often switch to an even more hurtful chant, “you don’t know what you’re doing, you don’t know what you’re doing”. It is sung to the tune of “Que sera, sera” (whatever will be, will be). Fatalistic, but apt.

Sounds good, but it´s not!

Draghi Warns on Risks of Low Inflation:

European Central Bank President Mario Draghi hit back at a warning from Germany’s Bundesbank that the ECB shouldn’t overreact to a sharp drop in oil prices, underlining his readiness to launch additional stimulus to shore up ultralow inflation.

In a speech at the Bundesbank’s home in Frankfurt, Mr. Draghi warned that central banks “cannot be relaxed” in the face of a series of shocks to commodity prices.

“The longer inflation stays too low, the greater the risk that inflation does not return automatically to target,” Mr. Draghi said.

Cheaper oil and other “forces in the global economy” that are holding down consumer prices “should not lead to a permanently lower inflation rate,” he said. “They do not justify inaction.”

The comments come a week after Bundesbank President Jens Weidmann urged central bankers to look through an oil-price driven drop in inflation, arguing that they shouldn’t fixate on current price levels like a “rabbit staring at a snake.”

The back-and-forth between two of Europe’s most influential central bankers underlines the debate within the ECB about how urgently the bank should respond to sharply lower oil prices.

It´s a mirror image of what happened in 2007-08, when oil prices were rising and central bankers felt “compelled” to tighten lest inflation permanently rose!

This is one more evidence against “Inflation Targeting”. It also shows how, in practice, central banks have an “asymmetric view” of the target!



“Close to, but below, 2%”: the ECB inflation ceiling. Its epitaph?

A James Alexander post

Of course we welcomed Mr Draghi’s willingness to ease monetary policy announced with at the January ECB meeting last week. And we recognised the positve impact on markets and therefore on NGDP expectations. But was this just a stopgap response to a poorer negative trend?

The fight over the direction of US monetary policy between the Fed and the markets will continue to dominate the news. The fight within the ECB will also continue, weakening the credibility of Mr Draghi’s easing bias and the current QE efforts. We think he should open a new front against the hawks by starting a discussion of the inflation target itself, the biggest barrier to optimal monetary policy in the Euro Area.

Wolfgang Munchau is right to despair after reading the minutes of the December 2015 ECB meeting.

The ECB has got itself into an extraordinarily difficult position. It has missed its policy target — a headline rate of inflation at “close to but below” two per cent — for four years. The target has lost credibility. Once people have lost confidence in an inflation target, it becomes very hard for the central bank to persuade them to trust the target again.

It was touching to hear Mr Draghi last Thursday talk about failing to reach a goal, then to try again and to fail again. I do not doubt his determination but the minutes of the December 3 meeting of the governing council tell us that not everybody supports the target in the same way. The minutes are anonymous. We know what has been said but not by whom.

What struck me in particular were two specific arguments used by some of the governors against a further increase in the size of asset purchases — part of the programme of quantitative easing aimed at revitalising the eurozone economy.

One said that he would not accept a further increase in QE unless the eurozone was once again in deflation. The implicit message of that statement is that this particular governor’s policy target must be zero per cent, not two per cent. He will only act once prices actually fall.

Another argument was that the positive effects of QE were diminishing over time while the negative side effects, like potential financial instability, were not. This argument is clever but also inconsistent with the policy goal. It is clever in the sense that it is self-fulfilling: if you choose not to increase the level of QE, then its effects diminish over time. And, of course, when the policy is not working, the adverse side effects may dominate.

However, what is infinitely more depressing in the minutes, and so sad too Munchau does not mention it, is the constant reference to the “close to, but below, 2%” inflation target. Expectations are almost everything in life, QE is fine but only as a tool to achieve a target. This inflation target undoes a huge part of the QE and general easing bias. Markets and economic actors know the ECB will tighten if inflation really does start to approach even 1.5% let alone 2%. Such tightening would then crush economic activity just as it did in in the Euro Area in 2008 and 2011.

European mainstream economists seem to think the ECB has a flexible target. But do these economists read the minutes of the policy-making body? It seems not.

Although we were encouraged by the near non-mention of the inflation ceiling target in the recent January ECB press conference, it’s dead hand still appeared, if very late in the statement, chilling all it touches.

Third quarter Euro Area economic growth was modestly encouraging. Signs are that 4Q will continue this trend, although monthly consumer inflation looks too weak for comfort. While many fret about headwinds from the China slowdown or US monetary tightening, the biggest headwind to Euro Area growth remains the inflation ceiling. Even if the Germans seem more inflation-phobic than ever, it would be nice to see some on the ECB open up a discussion about changing to a formally flexible inflation target, if not NGDP target like some Europeans have proposed.

More rays of light in the Euro Area

A James Alexander post

In a few decades, if the European monetary union experiment has failed, the gravestone will be marked with the utterly depressing and anti-stimulative inflation objective of “Below, but close to, two percent”.

You just knew the press conference after the ECB meeting this week was going to go badly when Draghi intoned the dreaded six words in the second paragraph of his opening statement. This was a record for the year in fact. My analysis shows that normally it is in the third paragraph, and at the last two press conferences it was rather excitingly relegated to the sixth and seventh paragraphs. There can be no convincing recovery in the Euro Area while there is an inflation ceiling like this.

Scott Sumner has already opined on the undoubted tightening of monetary policy today as markets reacted negatively: the Euro currency strengthened and stocks fell. He also correctly points out that expectations were running high.

However, the data from the rear view mirror isn’t too bad if you look at base money or NGDP growth. Draghi pointed out the strong growth of M1 at 11% before launching into the newer central bank creed of creditism. Loans were much cheaper, following bond yields down.

Of course, true success for his monetary easing would be bond yields rising. Ironically, on the day yields did rise. But this was more due to the disappointment of no additional QE bond buying rather than any additional hopes for a recovery. A sort of reverse liquidity effect (ie bonds had been overbought and fell back in price) rather than any Fisher effect (where higher nominal growth expectations cut the real return on bonds and their prices fall).

A growing debate on changing the mandate of the ECB

I am still looking for silver linings and was very interested to see this policy report from a pro-European think tank, the Centre for European Reform, with a very heavyweight Advisory Board of VSPs. The author, Christian Odendahl, recommends ending national monetary influences in the ECB Board – a great idea and one we alluded to recently. But even more he recommends investigating targeting a higher inflation rate, a level target and even Aggregate Demand.

A stable level of demand is crucially important in a monetary union, as excessively low demand can lead to regional depressions and soaring debt, destabilising the whole union in the process. The European Central Bank (ECB) has failed to maintain the necessary level of demand and inflation during the course of the eurozone crisis, and needs a stronger mandate to prevent this from happening in the future. Such a mandate should include a higher and symmetrical inflation target, as well as the explicit responsibility for maintaining an adequate level of demand. National central banks should no longer be involved in eurozone monetary policy, since they tend to politicise decisions along national lines.

Ideally, therefore, the ECB should be given a more robust and activist mandate to manage demand.

This mandate should include:

« A higher inflation target of 3 per cent so that interest rates can be lowered more in the event of a crisis.18

« An explicit commitment that this target be symmetrical, so that undershooting and overshooting the target are of equal concern.

« A provision to take overall demand into account, rather than just inflation. In 2011, for example, inflation rose but demand was weak – and the ECB made the wrong decision to raise interest rates, which weakened demand further. In such a situation, preference should not be given to inflation.

Odendahl also included a great, Marcus Nunes-style chart showing the colossal failure of the ECB to properly manage Aggregate Demand, aka Nominal GDP.

JA Draghi-1

Odendahl referred readers to the recent European Parliament hearing on NGDP Targeting. A draft of just one of the papers had found its way onto various blog sites but the link shows there were in fact three papers presented. I have reproduced all three abstracts of the final papers.

It is both fascinating and hopeful that academics from leading German, French and British economics departments were represented even if only one (can you guess which?) was clearly in favour. The two others were sympathetic but did go off on some strange tangents. One favoured flexible inflation targeting and thought NGDP  targeting wouldn’t help central banks with their central problem of “financial stability”. The third  favoured a complex amendment to the Taylor Rule.

Is nominal GDP targeting a suitable tool for the ECB’s monetary policy? 

We seek to clarify whether or not nominal GDP targeting (NGDP) may be a suitable tool for the ECB’s monetary policy. We argue that this question really consists of three distinct but related questions: (1) Is it better for the ECB to put more weight on output than it does currently, by switching to a NGDP target? (The theoretical evidence suggests, maybe, but this depends on the distortions faced by the economy.) (2) Should a NGDP (or inflation) target be formulated in rates of growth, or in levels? (The theoretical evidence suggests that a levels target may have some appealing properties, by stabilizing expectations.) (3) What technical issues remain to be addressed? (Issues include the selection of an operating instrument, difficulties in estimating trends, data revisions, and communication.) Altogether, we argue that thinking about nominal GDP targeting in this way might help to clarify what is otherwise a confusing debate.

(Wolfgang LECHTHALER, Kiel Institute for the World Economy; Claire A. REICHER, Kiel Institute for the World Economy; Mewael F. TESFASELASSIE, Kiel Institute for the World Economy)

Flexible inflation targeting vs. nominal GDP targeting in the euro area 

We assess the pros and cons of nominal GDP targeting vis-à-vis flexible inflation targeting regime. We show that the benefit of a regime shift towards nominal GDP targeting in the euro area might be small. Moreover, nominal GDP targeting is not concerned with financial stability. Finally, targeting nominal GDP would make ECB communication very difficult. If the aim of a regime shift were to bring the ECB to pay more attention to growth, it would be more straightforward to fix a dual mandate and to set an explicit target for real output growth or the unemployment rate.

(Christophe BLOT, OFCE/Sciences Po; Jérôme CREEL, OFCE/Sciences Po and ESCP Europe; Xavier RAGOT, OFCE/Sciences Po, CNRS and PSE)

Is Nominal GDP targeting a suitable tool for ECB monetary policy? 

The idea of targeting smooth growth for nominal income (GDP), as an alternative to the conventional Taylor or inflation targeting rules for setting monetary policy, has been in discussion for many years. But they have never been used in practice. In this paper we review the pros and cons of adopting such an approach, and find them to be rather finely balanced. To dig deeper, we consider certain particular features of nominal income targeting: the crucial role of supply side responsive- ness (nominal income targeting substitutes for poor responses or a lack of market or structural reform); the need to bring market forces into play; the question of whether income targeting increases discipline; and the extra constraints imposed by having a dual mandate. The upshot is that nominal income targeting emerges as a special case of the more flexible Taylor rule formulation, although it does generalise on pure inflation targeting. In practice the Taylor rule form may be improved by using time varying, state contingent coefficients. De facto, this is what the ECB has done in recent years. The simulation studies available suggest that the more flexible rules of this kind perform better in reducing the fluctuations of output and inflation away from target; and are, crucially, more robust to model uncertainty (important for design) and real-time data/information errors (important in implementation).

(Andrew HUGHES HALLETT, School of Economics and Finance, University of St Andrews, Scotland)