Sabine Lautenschläger Enters The Cave Of The Bavarian Lions

Sabine Lautenschläger 800x3951

James Alexander via Historinhas | In no other country in the euro zone is the public so intensely engaged with each monetary policy measures of the ECB as passionately as in Germany. This applies to the Bavarian public, which is particularly known for distinct opinions and clear announcements. Nowhere rate cuts, buying programs and negative (deposit) interest rates were so criticized as in Bavaria. Since I am a friend of clear words, I would stay in the cave of the Bavarian lions to represent goals, risks and side effects of the current monetary policy of the ECB.

Sabine Lautenschläger, member of the Executive Board of the ECB and former vice president of Bundesbank, went to defend the European central bank monetary policy, but what came out of news reports didn’t look promising. She was reported to have come out against further QE because things are not so bad on the outlook and monetary policy takes time to work. Well the outlook is poor even if there are some signs that in real time the Euro Area economy is picking up.

The old “long and variable lags” are a common mistake of many macroeconomists, that elevate some campaigning remarks once made by Milton Friedman against excess money growth into some sort of universal truth. Broad money growth may correlate with economic growth over long and variable lags, but not monetary policy, and not base money growth. We now know monetary policy is the market reaction to it, the setting of the SatNav, and not the often tortuous journey itself.

However, reading the excellent Google Translate version of the German-only speech shows her giving a surprisingly balanced speech.

The start was the usual claim, that:

The independence of central banks is a relatively young, but now an undisputed achievement.

Well, maybe, maybe not. The crushing of inflation may be a success but is also the crushing of nominal growth and a double-dip recession in the Euro Area an achievement?. More people should dispute this as an “achievement”. Perhaps she meant it is a negative achievement.

Then she entered into a fairly extensive discussion of the pros and cons of lower rates and low inflation. She nodded to savers who were complaining about low rates, but replied well that there would be less savings if economic growth collapsed.

Low interest rates are [nothing] that excites me – also because of the risks and side effects associated with them. However, the low interest is currently necessary and justified. I understand the concern [of] German savers who look with little enthusiasm on the yield of their passbook – I belong there also. Higher rates would stifle economic recovery and bring permanently low inflation, sustained economic downturn and more unemployment – and this would [restrict] the ability to save still much broader.[This almost verbatim Yellen´s answer to Ralph Nader]
[a few minor edits to Google Translate]

After dismissing the short-term impacts of lower energy prices on inflation, rather thinking they might somehow be expansionary, she moved on to outline the heart of Market Monetarism, the “musical chairs” problem.

Now many citizens are not overly concerned if the inflation rate is low [for] long. Here is but sometimes overlooked that not only high, but also such a low inflation rate has costs and entails risks.
A moderate inflation acts as a lubricant of economic growth by facilitating the adjustment of relative prices and, above all, wages. Price and wage adjustments are among the most important tools that companies have to improve their competitiveness. But studies show that companies reduce their salary payments only very rarely in absolute terms, but rather on clear rounds for their workforce. This works quite well in times of normal inflation of about 2% – as Germany has demonstrated in the first decade of this millennium. But if too low inflation[,] and the contention is that wage increases do not grow to the sky[,] the adjustment process is delayed. So low inflation abducted [ie blocks] sometimes necessary adjustment of relative wages and prices. The result is a rigid wage structure, higher unemployment and lower economic growth.
[a few minor edits to Google Translate]

The rest of the speech was not so good as this. We get the usual lecture on low rates reducing pressure on sovereign countries to reform, the danger of bubbles and mythical redistribution effects. Although on the last point she fights back well, lecturing the Bavarians on the need for a healthy Euro Area economy, the destination of 50% of the regions exports.

And she finished with the usual nonsense about monetary policy having limits, the need to wait and see and the fact that current data isn’t so bad. The last point may carry some weight, even.

However, Rome wasn’t built in a day. The lecture on nominal wage rigidity was a refreshing break from the past. Whether she really believes it doesn’t matter, the fact that it was in the speech is a great thing in itself, and those Bavarian lions had to listen.

Quite a contrast to the other German on the ECB Board, Jens Weidmann:

And we need to be aware that the longer we stay in ultra-loose monetary policy mode, the less effective this policy will become and the more the attendant risks and side-effects will come into play.

“Ultra-loose”, really? If it were ultra-loose why would financial markets price government bonds of the Euro Area’s strongest economy’s at negative rates six years out. Yes, six years out! How can Weidmann, also the head of the Bundesbank, make an elementary mistake like this. It is forgiveable for journalists and financial types, but not from a senior monetary policy maker. If he really thought that monetary polices were ultra-loose and inflation about to take off he could make a killing betting against such a foolish, foolish market. To help him out, and this is not investment advice, he should buy this. 

Also, disappointingly, he shows no respect for the independence of the central bank. He spends 80% of his speech lecturing politicians on how to do their jobs and just 20% on monetary policy. It was the usual list of macroeconomic imbalances, product and labour market imbalances, bank leverage, fiscal policy etc, etc. It’s ironic but there seems no symmetry when it comes to central banks throwing stones, especially the ECB, especially Bundesbankers. Central bankers are perfect of course, never themselves causing any problems, and certainly never saying “sorry”, or at least until years, or even decades later. I expect he would be outraged if a politician gave a speech on the economy and spent 80% lecturing the ECB on its responsibility.

And the 20% Weidmann spent on monetary policy he got wrong. Monetary policy is not ultra-loose. He shouldn’t let himself be blinded by low-interest rates but look at nominal growth expectations, 3% is tight by any standards, even by Euro Area standards.

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