By Brendan Brown *

Old, absurd and unfit for use; How else to describe the “new” monetary framework for the monetary policy of the euro presented by the head of the ECB Lagarde with great fanfare on Thursday 8 July?

Why old? The “new” framework is remarkably similar to the one unveiled in May 2003.

Why absurd? The main justification put forward for the framework is to work around a “zero limit” problem. This problem, however, is the ECB’s own initiative.

Why unsuitable for use? Chief Christine Lagarde tells us that the review has been undertaken to ensure that “our monetary policy strategy is fit for purpose both now and in the future”. But she does not consider any criticism of this strategy and does not advance any refutation. She does not explain why she expects better results from a plan so similar to the strategy pursued over the past quarter century.

What’s new in the plan?

The ECB has raised its inflation target.

So what’s up now? “Just under 2 percent”, the 2003 wording, was changed to “2 percent”. At the bottom of the text of the new framework is a reference to the knowledge gained since then on the severity of the monetary policy paralysis that can occur when inflation drops too far. This discovery, we are told, warrants greater leniency in accepting inflation overrun for a period of time. The reader then comes to the gibberish expression “price stability is best maintained by targeting an inflation target of 2% in the medium term”.

The ECB has adopted many radical new tools to achieve this. Following on from the 2 percent statement, the ECB confirms that interest rate fixing remains the main tool, but many other tools are also available:

The Governing Council also confirmed that the ECB’s interest rate series remains the main instrument of monetary policy. Other instruments, such as forward guidance, asset purchases and longer-term refinancing operations, which, over the past decade, have helped ease the limitations generated by the lower bound of interest rates. Nominal interest rates will remain an integral part of the ECB’s toolkit, to be used where appropriate.

In other words, the new plan tells us that the ECB plans to be much more militant and that it plans to use many “tools” that were once considered unacceptably radical.

Remember the spring of 2003, when Professor Otmar Issing presented the new ECB framework. The salient point then was that the ECB would aim for inflation of just under 2 percent, ready to take decisive action to prevent inflation under and overshoot. In response to a question, he insisted that the ECB has practically followed this policy framework since the launch of the euro (1999), even though its formal target was simply inflation below 2 percent, which in principle could have meant mostly zero inflation.

At the time of the last review, Professor Issing was still very respectful of a second pillar of ECB policymaking based on a broad money supply growth surveillance range. There was then no mention of QE, forward guidance, manipulation of long-term rates and these tools were not accepted as legitimate. The legitimacy and application of these “unconventional tools” came amid the sovereign and bank debt crises of 2010-12. They were presented as essential for monetary control. Everyone and their dog, however, realized that their main goal was for the ECB to make massive remittances to support weak sovereigns and their banks. Now this pretext has become part of the new framework.

Manage price inflation expectations

One might have expected a certain setback against all this from the Bundesbank or the Dutch National Bank. There is no evidence of this, except indirectly in the grant by the ECB of a misunderstanding. Its review indicates that the inflation estimate for targeting should be changed over time to reflect the cost of owner-occupied housing.

It is a reed of very weak challenge. The ECB tells us that the cost of owned housing now needs to be estimated in a “stand-alone index” and this should be seen in a broader context of assessing monetary conditions for the coming years. Ultimately, by the mid-2020s, the ECB predicts that there will be a modified HICP (Eurozone CPI) that includes this estimate of the costs of owner-occupied housing, but the owner does not. will be fully operational as a target variable only at the end of the 2020s. Who knows; by then, the dramatic spike in house prices across much of the euro area, including Germany and the Netherlands in recent years, may have reversed, meaning the HICP will be reformed in a leadership which in fact calls for an even more radical European monetary policy. Politics.

Why is the new plan necessary?

The ECB is arguing that its new “framework” has become necessary because the “zero limit” problem has become so serious. That is, with interest rates already so low, it is assumed that the central bank needs new tools to drive up price inflation, even with target interest rates already zero or less than zero. This is due, he says, to problems beyond his control. “Structural developments have lowered the equilibrium real interest rate – declining growth in productivity, demographics and ever higher demand for safe liquid assets. As a result, the incidence and direction of episodes in which nominal policy rates are close to the effective lower bound have increased – the current episode lasting more than 10 years ”.

The ECB will not solve the problem created by the ECB

What nerve ! This so-called problem of “extraordinarily low real equilibrium rates” is a problem of the central bank’s own. The European sovereign and banking debt crisis of 2010-12, the trigger for the initial downward forces on the real equilibrium rate, was itself a consequence of ECB policy during the years 1997-2007. This was a very inflationary situation, although the symptoms were more clearly visible most of the time in asset markets than in goods and services markets. By targeting 2% inflation in a time of rapid productivity growth and globalization, also with downward pressure on prices due to increased competition within EMU, the ECB has fueled monetary inflation .

The “real equilibrium rates” have remained so low well beyond the crises of 2008-12 and their immediate consequences precisely because the policies of the ECB have induced and added to economic sclerosis. Its radicalism, characterized by negative interest rates and vast quantitative easing operations centered on the rescue of sovereigns and weak banks, has undermined any potential dynamism of European economies.

Examples of how the ECB has contributed to economic sclerosis include the fantastic gravy train in Italy that has fortified the status quo there but stifled all creative destruction, including liquidation of the big government and cronyism; stimulating a boom in financial engineering and more broadly financial speculation in which investors seek high apparent returns based on camouflaged leverage and other optical illusions rather than potential returns on spending long gestation investment; the generation of massive capital exports as the starvation of interest income European investors seek seemingly high returns abroad, especially in high-risk credit markets and also in the El Dorado of US monopoly capitalism ( in particular the big five FAAAM), itself a dead hand which stifles economic dynamism on a global scale; fueling a tremendous boom in real estate construction, especially in Germany, which is not generating productivity growth; creating desperation among some households about negative returns on their savings and the ultimate prospects of cutting their pensions in the midst of the next financial crisis and thus forcing them to curtail their spending.

Unhealthy money, be it the Fed, the ECB or the Bank of Japan, produced a seemingly low equilibrium interest rate and allegedly (according to the central bank account) below zero.

Sound currency, not digging around the current monetary framework, is the answer to the zero-rate frontier problem.

* About the Author: Brendan Brown is a founding partner of Macro Hedge Advisors (www.macrohedgeadvisors.com) and Principal Investigator at the Hudson Institute. As an international monetary and financial economist, consultant and author, he notably held the position of Head of Economic Research at Mitsubishi UFJ Financial Group. He is also Senior Fellow of the Mises Institute. He is the author of Europe’s Century of Crises Under Dollar Hegemony: A Dialogue on the Global Tyranny of Unhealthy Money with Philippe Simonnot. His other books include The case against 2 percent inflation (Palgrave, 2018) and is editor of “Monetary Scenarios”, Euro crash: how asset price inflation destroys nations’ wealth and The Federal Reserve’s Global Curse: Manifesto for a Second Monetarist Revolution.

Source: This article was published by the MISES Institute