Why Draghi was wrong to cut interest rates

Autor/en
Hans-Werner Sinn
Financial Times, 14 November 2013, S. 9

Europe fears the Japanese disease. In Japan, the gross domestic product deflator - a broad measure of the price level -  fell by about 1.2 per cent a year from 1999 to 2013. Today it is as low as it was in 1980. This was a catastrophe, which Japan may only now be overcoming with its Abenomics aimed at a devaluation of the yen.

The eurozone GDP deflator was only 1.6 per cent higher in the second quarter of 2013 than a year before. The consumer price index by October had increased by merely 0.7 per cent. These are low figures indeed. Seen this way, the European Central Bank's fear of deflation - and last week's interest rate cut - is understandable.

However, deflation in parts of a currency union is not the same as deflation of a union as a whole, because its internal effects on competitiveness cannot be compensated for by exchange rate adjustments. In fact, Greece, Spain and Portugal need to devalue in real terms by about 30 per cent relative to the eurozone average in order to correct the distortions that were brought about before the crisis by the inflationary credit bubble created by the Single currency and thus restore their competitiveness. The ECB should not act against moderate deflation in these countries, but rather aim to offset such deflation by inflating the northern eurozone - Germany, in particular. For this, restraint - not activism - is needed.

The market has been preparing for such a realignment of relative prices. German savers and institutions have turned towards their domestic property market, causing a construction boom that has made labour scarce, increased wages and could ultimately result in general pay and price inflation. The new boom has the potential to reduce Germany's much-criticized current account surplus.

Paradoxically, the ECB is actively operating against such a self-correction. With its Outright Monetary Transactions programme, through which its offers to purchase government bonds of troubled countries at the taxpayers' risk, the bank is escorting private German savings again to southern Europe, where they are reluctant to go voluntarily. The ECB has also been relocating its (electronic) printing presses from the northern to the southern central banks through its policy of allowing junk assets to be used as collateral for its lending to needy commercial banks. These schemes have exported more public capital from north to south than the official rescues.

Four-fifths of the eurozone's monetary base has been created through open-market and refinancing Operations by the central banks of the six official crisis countries. None of the base has been created through such operations by the Bundesbank and practically none by the Bank of Finland. All central bank money issued in Germany effectively comes from abroad.

The money available at low interest from southern printing presses has calmed the capital markets. But this has come at the price of slowing the realignment of the relative prices of goods needed for improving competitiveness. As the International Monetary Fund notes, hardly any of the recent trade improvements in the south have come from increased competitiveness. Industrial production in Italy, Spain and Greece has fallen dramatically.

The ECB's policy may even be responsible for part of Germany's current account surplus. Money from the southern printing presses was used not only to buy goods and assets inside the eurozone and to redeem eurozone debt. It also flowed to the international currency markets to buy assets and redeem none eurozone debt. This depressed the euro exchange rate enough to allow Germany to run its disturbingly large surplus despite the deficits of southern Europe and Ireland disappearing. After criss-crossing the world, money from southern printing presses bought German goods.

Germany's current account surplus in the five crisis years from 2008 to 2012 was € 798 bn. Usually; such a surplus would lead to the accumulation of marketable foreign assets by the private sector. Not this time. Three-quarters of Germany's surplus, € 585 bn, was paid for with money created by the central banks of other eurozone countries. The Bundesbank acquired claims on other eurozone central banks in exchange, which now carry a mere 0.25 per cent interest rate.

This all calls to mind a doctor who does not understand the disease he wants to cure being surprised by grave, unanticipated side effects. The Maastricht treaty did not give the ECB a mandate similar to the US Federal Reserve's for a reason. Even the Fed never carried out the regional fiscal policy that the ECB governing council, with its semantic skills, has conducted in the name of monetary policy. If the ECB stuck to a more conventional definition of monetary policy it would give markets a better chance of correcting Europe's imbalances. The resulting German inflation, matched by a moderate southern European deflation, would do wonders to help avoid the Japanese disease.