The ECB supports banks, not the economy
Recently the ECB announced a new round of quantitative easing (QE): the ECB buys large volumes of (bad) financial paper, so as to improve the financial situation of banks. By doing this the ECB hopes to improve the trust of investors in the economy. In this short essay we will explain why this policy will not contribute to the necessary recovery in terms of employment and growth in well-being of the mass of the people. More effective methods, such as monetary financing of government investments, are excluded by the Maastricht Treaty.
In section 2 we explain why monetary policy in a balanced economy is quite different from monetary policy in an economy, which is out of balance (Leijonhufvud, 2009). In section 3 we discuss the way we should tackle the European macroeconomic problem. In section 4 we draw a few conclusions.
- Monetary Policy in the High Corridor
Macroeconomic developments are characterized by long periods of stability on a high level of employment, followed by periods of stability on a significantly lower level of employment. In the first situation the economy shows its fluctuations in a high corridor, while in the second situation the business cycles stay within a low corridor. The corridors are determined by the level of optimism and pessimism of the investors and consumers. In the first corridor the economy fluctuates between a state of recovery, hausse, recession and back to recovery. In the second corridor the economy fluctuates between different levels of growth, while the investors and consumers are structurally pessimistic. In other words, the economy is in a depression. Neoclassical and monetarist economists assume that a free market economy is a stable system in the high corridor, as long as the institutions don’t affect the processes of price adjustments. Post-Keynesians, however, assume that in case of a depression, a free market economy does not have a mechanism that brings the economy back to the first corridor. To stay in in the first corridor an economy needs a series of institutions, which must prevent a fall back to a state of depression. These institutions must create a power balance on the labour and the financial market. Free market economies offer too much room for capitalists to serve their own interests, at the cost of the well-functioning of the economy and society as a whole. Growing inequality and lower economic growth are the result, unless the government offers a countervailing power.
According to the monetarists an economy, which is close to full employment, needs a monetary policy that aims at price stability and a level of the interest rate, which stimulates the economy in times of recession, and slows down the economy in times of a hausse. In the current situation the European economy does not only face a recession, but also an ailing banking system. Without a well-functioning banking system, sustainable growth is impossible. The instrument of quantitative easing must support those banks, which solvency and liquidity ratio’s are extremely low. According to the post-Keynesians the European economy is characterized by depression, not by recession. In the next section we will see how they analyse the situation, and which policy recommendations belong to that different analysis.
Monetary Policy in the Low Corridor
According to the post-Keynesians an economy in the low corridor needs a monetary policy, which accompanies the development of the real economy, without trying to affect its development actively. Depressed consumers and investors do not react upon small price adjustments – they look primarily at the development of production, income and employment. As long as these variables do not show a significant increase, the spenders wait, and use there resources to pay–off their debts and to increase their savings. Only the government can solve this (prisoner’s) dilemma. It should increase its investments, and finance it by means of money creation (monetary financing). If it would finance the additional investments by means of private capital, it might lead to an increase in the interest rate, which has a procyclical effect. If the government offers the central bank financial paper with an eternal term and a zero interest rate, it does not even lead to an increase of the government debt ratio. A positive side-effect is that private banks can focus on a brokers function on the capital market, without making their position more fragile through net money creation.
A banking crisis, coming from the USA, brought the global economy in a depression. The EU refused to move to a lower corridor policy. Its high corridor policy has worsened the situation. Now the time has come that the negative social effects become visible. Very high rates of unemployment and ongoing decline in wages, while the elite is still talking about a recession, have made people desparate. This is a threat for societal stability. Now Meditterranean voters speak, it is time for the EU-elite to reflect upon their Selves. How come that we are still so blind, and don’t see what is so obvious for so many people?
Dr. Piet Keizer
Associate Professor Economic Methodology
Utrecht Universityschool of Economics
Word count: 842.