Click amount to donate direct to CounterPunch
  • $25
  • $50
  • $100
  • $500
  • $other
  • use PayPal
Keep CounterPunch ad free. Support our annual fund drive today!

The Cult of Incompetent Bankers


The world financial system had another serious scare last week. The immediate issue was the prospect that the euro could break up. With the debt crisis spreading from smaller countries such as Greece and Ireland to the eurozone giants of Spain and Italy, events were again getting scary.

A default by the smaller countries would create serious disruptions throughout the eurozone and the larger world economy, but no one doubts that these could be contained. The European Financial Stabilization Fund (EFSB) is large enough to paper over the mess that would be created by the default of Greece or Ireland.

However the default of Spain or Italy is an entirely different matter. If either country were to default, the repercussions would be enormous, dwarfing the resources of the EFSB. A default would almost certainly make several major European banks insolvent and lead to the sort of freeze-up of the financial system that we saw after the bankruptcy of Lehman in September of 2008. With the interest rate on Italian and Spanish debt soaring, the financial markets had to take this risk seriously.

The European Central Bank (ECB) rose to the immediate challenge, buying up large amounts of both governments’ debt and committing itself to buy more if necessary. This re-established confidence in the market and for the moment at least seems to have brought the crisis under control. Still, it is unlikely that anyone would bet that Europe and the world are through with this set of problems and for this the ECB bears an enormous amount of blame.

Just to be clear, this whole crisis came about because central banks did not take seriously their responsibility for maintaining the stability of the overall economy. They held the view that as long as the inflation rate was low and steady then everything else would take care of itself.

In the United States this meant ignoring the growth of an $8 trillion housing bubble, even though this bubble had clearly become the motor of the economy with near-record rates of construction and a housing equity driven consumption boom. In Europe, the ECB failed to notice housing bubbles through much of the eurozone, but most notably the ones in Spain and Ireland that were leading to massive borrowing and unsustainable current account deficits.

However, the Federal Reserve Board has at least been relatively aggressive in responding to the crisis, pushing its overnight lending rate to zero and buying up nearly three trillion dollars in long-term bonds through repeated rounds of quantitative easing. Last week it committed to keeping its overnight lending rate at zero for the next two years.

By contrast, the ECB seems determined to learn nothing from its past errors. It never lowered its overnight lending rate below 1.0 percent and never pursued quantitative easing as aggressively as the Fed. Even worse, it remains committed to its 2.0 percent inflation target as though nothing in the world had changed since the collapse of the bubble. As a result of this commitment, it has actually been raising interest rates in a deliberate effort to slow the eurozone’s economy and dampen inflation.

This policy is incredible for three reasons. First, Europe has no real inflation problem. The rise in the inflation rate targeted by the ECB comes almost entirely from the rise of the price of oil and other commodities. These price increases are the result of the growth in demand in places like China and India. They have almost nothing to do with growth in Europe and will not be reversed by a tighter ECB policy.

The second reason this policy is foolish is that the eurozone countries desperately need a boost from lower interest rates. The heavily indebted countries are all being required to implement austerity plans with large reductions in government spending and tax increases. This will further weaken demand in already depressed economies. Lower interest rates may not be the best way of boosting demand, but they are better than nothing. It is difficult to believe that the ECB would actually want to magnify the contractionary impact of fiscal austerity, but this is exactly what its policy is doing.

The third reason why this policy is foolhardy is that it will likely worsen the interest burden that the heavily indebted countries already face. If they have to pay higher interest rates on their debt then the problem of keeping the debt at a sustainable level becomes much more difficult. Of course the higher unemployment produced by fiscal austerity coupled with monetary contraction will also make it more difficult for these governments to hit their deficit targets.

A central bank that was committed to maintaining stability and laying the basis for future growth would be doing everything it could to promote expansion in the eurozone right now. This would mean at the least lowering the overnight lending rate to near zero. It would also mean large amounts of quantitative easing to directly reduce long-term interest rates. And it could even deliberately target a higher inflation rate (e.g. 3-4 percent) to reduce real interest rates enough to boost the economy. This is what a central bank would do if it was committed to economic growth and stability rather than worshipping a 2 percent inflation rate.

Unfortunately, there is no mechanism to force the ECB to end its obsession with its antiquated 2 percent inflation rule. It is a self-contained bureaucracy, just like the Communist Party in the days of the Soviet Union. The only people whose views matter are ones who have already committed themselves to the ideology, Communism in the case of the Soviet Union, 2.0 percent inflation in the case of the ECB. The inhabitants of the eurozone, like the rest of the world, will just have to wait for the wall to fall.

Dean Baker is the co-director of the Center for Economic and Policy Research (CEPR). He is the author of Plunder and Blunder: The Rise and Fall of the Bubble Economy and False Profits: Recoverying From the Bubble Economy.

This article originally appeared International Relations and Security.

Dean Baker is a macroeconomist and co-director of the Center for Economic and Policy Research in Washington, DC. He previously worked as a senior economist at the Economic Policy Institute and an assistant professor at Bucknell University.

More articles by:

2016 Fund Drive
Smart. Fierce. Uncompromised. Support CounterPunch Now!

  • cp-store
  • donate paypal

CounterPunch Magazine


October 26, 2016
John W. Whitehead
A Deep State of Mind: America’s Shadow Government and Its Silent Coup
Anthony Tarrant
On the Unbearable Lightness of Whiteness
Mark Weisbrot
The Most Dangerous Place in the World: US Pours in Money, as Blood Flows in Honduras
Eric Draitser
Dear Liberals: Trump is Right
Chris Welzenbach
The Establishment and the Chattering Hack: a Response to Nicholas Lemann
Luke O'Brien
The Churchill Thing: Some Big Words About Trump and Some Other Chap
Sabia Rigby
In the “Jungle:” Report from the Refugee Camp in Calais, France
Linn Washington Jr.
Pot Decriminalization Yields $9-million in Savings for Philadelphia
Pepe Escobar
“America has lost” in the Philippines
Pauline Murphy
Political Feminism: the Legacy of Victoria Woodhull
Lizzie Maldonado
The Burdens of World War III
David Swanson
Slavery Was Abolished
Thomas Mountain
Preventing Cultural Genocide with the Mother Tongue Policy in Eritrea
Colin Todhunter
Agrochemicals And The Cesspool Of Corruption: Dr. Mason Writes To The US EPA
October 25, 2016
David Swanson
Halloween Is Coming, Vladimir Putin Isn’t
Hiroyuki Hamada
Fear Laundering: an Elaborate Psychological Diversion and Bid for Power
Priti Gulati Cox
President Obama: Before the Empire Falls, Free Leonard Peltier and Mumia Abu-Jamal
Kathy Deacon
Plus ça Change: Regime Change 1917-1920
Robin Goodman
Appetite for Destruction: America’s War Against Itself
Richard Moser
On Power, Privilege, and Passage: a Letter to My Nephew
Rev. William Alberts
The Epicenter of the Moral Universe is Our Common Humanity, Not Religion
Dan Bacher
Inspector General says Reclamation Wasted $32.2 Million on Klamath irrigators
David Mattson
A Recipe for Killing: the “Trust Us” Argument of State Grizzly Bear Managers
Derek Royden
The Tragedy in Yemen
Ralph Nader
Breaking Through Power: It’s Easier Than We Think
Norman Pollack
Centrist Fascism: Lurching Forward
Guillermo R. Gil
Cell to Cell Communication: On How to Become Governor of Puerto Rico
Mateo Pimentel
You, Me, and the Trolley Make Three
Cathy Breen
“Today Is One of the Heaviest Days of My Life”
October 24, 2016
John Steppling
The Unwoke: Sleepwalking into the Nightmare
Oscar Ortega
Clinton’s Troubling Silence on the Dakota Access Pipeline
Patrick Cockburn
Aleppo vs. Mosul: Media Biases
John Grant
Humanizing Our Militarized Border
Franklin Lamb
US-led Sanctions Targeting Syria Risk Adjudication as War Crimes
Paul Bentley
There Must Be Some Way Out of Here: the Silence of Dylan
Norman Pollack
Militarism: The Elephant in the Room
Patrick Bosold
Dakota Access Oil Pipeline: Invite CEO to Lunch, Go to Jail
Paul Craig Roberts
Was Russia’s Hesitation in Syria a Strategic Mistake?
David Swanson
Of All the Opinions I’ve Heard on Syria
Weekend Edition
October 21, 2016
Friday - Sunday
John Wight
Hillary Clinton and the Brutal Murder of Gaddafi
Diana Johnstone
Hillary Clinton’s Strategic Ambition in a Nutshell
Jeffrey St. Clair
Roaming Charges: Trump’s Naked and Hillary’s Dead
John W. Whitehead
American Psycho: Sex, Lies and Politics Add Up to a Terrifying Election Season
Stephen Cooper
Hell on Earth in Alabama: Inside Holman Prison
Patrick Cockburn
13 Years of War: Mosul’s Frightening and Uncertain Future