In remarks at Jackson Hole, Wyoming, European Central Bank president Mario Draghi urged greater fiscal and monetary coordination to boost the E.U.’s economy. A ship cannot move along at full speed if all the sails are not coordinated so that each is poised at its optimal angle to the prevailing winds. So too, various policies in a political economy must all sail in the same direction for a full-sail recovery to really take off. Just as a sailing ship must avoid jagged pitfalls lurking in rocky waters, so too must policy makers; for it is all too easy in focusing on one point on the horizon to ignore or dismiss baleful downsides to the dominant policies.
At the foot of the Teton Mountains, there being no foothills, Draghi “called for explicit policy co-ordination between the [Eurozone’s] monetary guardian and [the states].”[1] Brandishing considerably less concern on inflation, he linked the ECB’s future purchases of state bonds (i.e., quantitative easing, or QE) to structural reforms, tax cuts, and more spending at the state level.
At the time, E.U. law limited state budget deficits to 3% of gross domestic product. Pointing to the existing flexibility in that law, the central banker urged the state governors to “better address the weak recovery and to make room for the cost of needed structural reforms.”[2] I submit that the accent should be placed on the latter, as they would have more staying power. It is like the difference between consuming sugar (even in fruit) before running, and drinking a protein shake after lifting weights; both food elements are helpful, but only the protein becomes a part the body and can thus strengthen it for the future.
Quantitative easing can unfortunately impact an economy in
both foreseen and unforeseen ways due to the intended artificially-low interest
rates. The market-mechanism cannot but be distorted, with harsh byproducts free
to silently ravage certain segments while others benefit without merit. The
human brain is not so omniscient as to be able to fully anticipate and plug all
the leaks that can arise from a systemic distortion in a macro-economy. That is
to say, the system is so complex that a huge distortion using one macro policy
tool can introduce significant systemic risk.
In the U.S., for example, low rates in the 1990s
incentivized a housing bubble whose collapse in 2007 triggered the potentially
catastrophic credit freeze and collapse of Lehman Brothers in September of
2008. The government bailout of GM, AIG, and Wall Street banks worsened the
federal public debt. By 2014, that debt reached over $17 trillion. Meanwhile,
the Federal Reserve printed money far exceeding the meager growth of GDP by
buying bonds to artificially lower interest rates to prompt a recovery.
With interest rates low, money flooded into stocks. “The
market is in effect rigged because of the [low] interest rate,” Charles
Biderman said on CNBC as the summer of 2014 was coming to an end.[3]
A grinding ethical fault-line ran between the stocks increasing at 25% a year and
the wages and salaries increasing at a mere 3 percent. Moreover, the middle and
lower economic classes would doubtless feel the brunt of a collapse of the
stock market due to irrational fear should rates be raised to counter the
inflation from too many dollars chasing too few goods.
With borrowing money being so cheap at the low rates,
government officials did not feel the normal market pressure to hem in the
deficits. Corporate managements could borrow money cheaply to acquire or merge
with other companies without being perhaps as discerning of the degree of
compatibility and synergy as would be the case under naturally determined
interest rates. In 2014 through August, more than $2 trillion in mergers and
acquisitions were announced—an increase of 70 percent over the same period the
year before.[4]
While managers, stockholders, and lawyers make out like bandits on the deals,
subordinate employees are left out of the largess and may even lose their jobs
as the price of synergy.
As dark as the underside of quantitative easing is in
pushing rates abnormally low, the most potentially harmful byproduct of
Draghi’s plan concerns his intent to encourage the E.U.’s state governments to
make greater use of the “existing flexibility” already in the federal law
limiting state budget deficits to 3% of annual economic output. Even large
states such as France and Germany had had trouble keeping within the law;
states such as Greece, Spain, and even Italy carried so much debt that the
systemic risk of default became a problem not just for the E.U., but for the
global financial system as well. To encourage
flexibility might be like giving money to an alcoholic standing outside a
liquor store. The last thing state legislators need to hear is additional
flexibility to tax less and spend more can be found in the fine print.
As an alternative, Draghi could have emphasized that the ECB
would focus on assisting states with structural reforms both by lending its
expertise and finding the right monetary incentives that would not distort the
financial market in potentially unforeseen ways. Sticking to old ways is not
necessarily the best route to getting structural changes capable of ushering in
new ways.
1. Claire Jones, Peter Spiegel, and Robin Harding, “Draghi Softens Tone on Austerity,” The Financial Times, August 22, 2014.
2. Ibid.
3. Charles Biderman, CNBC TV, August 28, 2104.
4. Trish Regan, “Has Fed Jumped the Shark?” USA
Today, August 26, 2014.
