FacebookTwitterGoogle+RedditEmail

The Cult of Incompetent Bankers

by DEAN BAKER

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:

CounterPunch Magazine

minimag-edit

bernie-the-sandernistas-cover-344x550

zen economics

March 28, 2017
Mike Whitney
Ending Syria’s Nightmare will Take Pressure From Below 
Mark Kernan
Memory Against Forgetting: the Resonance of Bloody Sunday
John McMurtry
Fake News: the Unravelling of US Empire From Within
Ron Jacobs
Mad Dog, Meet Eris, Queen of Strife
Michael J. Sainato
State Dept. Condemns Attacks on Russian Peaceful Protests, Ignores Those in America
Ted Rall
Five Things the Democrats Could Do to Save Their Party (But Probably Won’t)
Linn Washington Jr.
Judge Neil Gorsuch’s Hiring Practices: Privilege or Prejudice?
Philippe Marlière
Benoît Hamon, the Socialist Presidential Hopeful, is Good News for the French Left
Norman Pollack
Political Cannibalism: Eating America’s Vitals
Bruce Mastron
Obamacare? Trumpcare? Why not Cubacare?
David Macaray
Hollywood Screen and TV Writers Call for Strike Vote
Christian Sorensen
We’ve Let Capitalism Kill the Planet
Rodolfo Acuna
What We Don’t Want to Know
Binoy Kampmark
The Futility of the Electronics Ban
Andrew Moss
Why ICE Raids Imperil Us All
March 27, 2017
Robert Hunziker
A Record-Setting Climate Going Bonkers
Frank Stricker
Why $15 an Hour Should be the Absolute Minimum Minimum Wage
Melvin Goodman
The Disappearance of Bipartisanship on the Intelligence Committees
Patrick Cockburn
ISIS’s Losses in Syria and Iraq Will Make It Difficult to Recruit
Russell Mokhiber
Single-Payer Bernie Morphs Into Public Option Dean
Gregory Barrett
Can Democracy Save Us?
Dave Lindorff
Budget Goes Military
John Heid
Disappeared on the Border: “Chase and Scatter” — to Death
Mark Weisbrot
The Troubling Financial Activities of an Ecuadorian Presidential Candidate
Robert Fisk
As ISIS’s Caliphate Shrinks, Syrian Anger Grows
Michael J. Sainato
Democratic Party Continues Shunning Popular Sanders Surrogates
Paul Bentley
Nazi Heritage: the Strange Saga of Chrystia Freeland’s Ukrainian Grandfather
Christopher Ketcham
Buddhism in the Storm
Thomas Barker
Platitudes in the Wake of London’s Terror Attack
Mike Hastie
Insane Truths: a Vietnam Vet on “Apocalypse Now, Redux”
Binoy Kampmark
Cyclone Watch in Australia
Weekend Edition
March 24, 2017
Friday - Sunday
Michael Hudson
Trump is Obama’s Legacy: Will this Break up the Democratic Party?
Eric Draitser
Donald Trump and the Triumph of White Identity Politics
Jeffrey St. Clair
Roaming Charges: Nothing Was Delivered
Andrew Levine
Ryan’s Choice
Joshua Frank
Global Coal in Freefall, Tar Sands Development Drying Up (Bad News for Keystone XL)
Anthony DiMaggio
Ditching the “Deep State”: The Rise of a New Conspiracy Theory in American Politics
Rob Urie
Boris and Natasha Visit Fantasy Island
John Wight
London and the Dreary Ritual of Terrorist Attacks
Paul Buhle
The CIA and the Intellectuals…Again
David Rosen
Why Did Trump Target Transgender Youth?
Vijay Prashad
Inventing Enemies
Ben Debney
Outrage From the Imperial Playbook
M. Shadee Malaklou
An Open Letter to Duke University’s Class of 2007, About Your Open Letter to Stephen Miller
Michael J. Sainato
Bernie Sanders’ Economic Advisor Shreds Trumponomics
FacebookTwitterGoogle+RedditEmail