by Erik Jones

Central Bankers Seeking Normal

There is an ongoing debate about when (not whether) the Federal Reserve in the United States and the Bank of England will raise interest rates. Opponents of such a move acknowledge that interest rates have to go up some time but argue that the ongoing weakness in Europe, the slowdown in emerging market economies, and the turmoil in China are all good reasons to wait as long as possible. Proponents of an early rise worry about the distortions caused by prolonged ultra-low interest rates. They also want to bring interest rates up again so that they will have something to cut should they run into trouble in the future.

This debate may seem like the usual macroeconomic conversation you would expect to hear among central bankers and yet it is not. There is an underlying political controversy around central banking that creates an incentive for central bankers to move more quickly in raising interest rates than economic conditions might warrant. This controversy takes place any time central bankers approach the frontier between ‘conventional’ and ‘unconventional’ monetary policy; it gets stronger and more intense once they crossover and start using unconventional monetary policy instruments; and it lasts until central bankers find a way to return to normal.

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by Erik Jones

The ECB’s Diminishing Room for Manoeuvre

European Central Bank (ECB) President Mario Draghi did not disappoint. In his first post-summer press conference, he responded to the recent volatility on Chinese equities markets – and across emerging markets more generally – by promising to relax monetary policy as much as necessary to shore up Europe’s fragile recovery. He articulated the promise in the form of a three-fold commitment: to expand the share of individual bond issues that the ECB could purchase without giving the central bank unwarranted market power; to maintain the pace of monthly asset purchases; and to loosen monetary policy even further ‘by using all instruments available within its mandate’ particularly as this refers to ‘the horizon, the size, and the parameters’ of ‘the asset purchase programme’. Market participants were quick to respond. The euro weakened against the dollar; equity prices rose on European stock markets; and the yields on European sovereign debt instruments declined.

It is easy to interpret living up to expectations as a sign of the ECB’s continuing influence over the markets. ‘Never bet against Draghi,’ is a popular banter among analysts. The transcript of the press conference tells a different story. Time and again, Draghi explains how his quantitative easing program has underperformed due to the influence of exceptional factors. Periodic declines in commodity prices, prolonged weakness in emerging market economies, increasing volatility in asset prices, and adverse movements in exchange rates between major currencies all contribute to the explanation. Of course the ECB could try again and harder, but why should the next time be any different? This question is not simply a rhetorical flourish. The canned opening statement only makes sense if the first commitment to quantitative easing was a failure.

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by Erik Jones

The European Political Centre Cannot Hold (But the EU Can)

Europe’s politicians have cleared the last hurdle in accepting Greece’s third financial bailout but the voting was uncomfortable for everyone. The left-wing populist government in Greece relied on representatives from the more traditional centre-left and centre-right to cover for defections from the ruling coalition; the German government used Social Democrats within the ruling coalition to cover for defections from the Chancellors own Christian Democrats; and the Liberal (VVD)/Party of Labour (PvdA) government the Netherlands got extra support from the left-liberal D66 party to add to its slender one-seat majority.

As a result of these different movements toward the political centre – and similar developments in other countries – the Greek government will get the money it needs to keep up with its debt payments and shore up its banks. That is a good thing for anyone who wants to see Greece have a reasonable chance at recovering from this ongoing crisis. Unfortunately, that centre cannot hold. A populist party like Syriza cannot govern easily with the old pillars of the Greek political establishment; Germany’s grand coalition is an historical anomaly; and the result of eight years of close cooperation between VVD, PvdA and D66 was bad for all. So the question is whether Europe’s political centre will splinter before the Greek situation becomes sustainable.

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by Erik Jones

The EU Needs to Admit Mistakes

The European Union (EU) is good at writing rules; what it needs to strengthen the capacity to suspend, ignore, or replace rules that are obviously not working or inappropriate in a given situation. In other words, the EU needs to get better at recognizing when following the rules is a mistake. This is not going to be a popular argument. Rules are supposed to be rules, after all. Nevertheless, it is vital. So long as policymakers lack perfect foresight, they will never be able to write rules that work in every situation. They will not be able to anticipate the conditions for every possible exception either. Hence they will always need some mechanism to recognize and respond to unexpected situations in a timely manner. In case of emergency, break glass. They will also need some way to hold policymakers accountable for any exercise in emergency discretion. Successful innovations will not always be rewarded but they will be accepted and used to improve the functioning of the organization; abuse will be punished. That is – or at least should be – the  measure of political union.

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by Erik Jones

The Trouble with Transfer Unions

The European Union is starting a big debate about fiscal federalism. There are many questions involved. The one I want to focus on is whether a Europe-wide fiscal arrangement with common transfers would help smooth economic performance across participating countries while at the same time helping them to converge on similar levels of income per capita. The line you often hear is that this is how federal transfers work in the United States: rich states like New York and Massachusetts bankroll poorer states in the south and west of the country both when times are tough and in order to foster the whole of the U.S. economy.

In reality, the U.S. federal transfer system does not work that way. The richer states in the north-east of the country get more federal transfers per capita than the poorer states in the south and west. The reason is that the U.S. federal fiscal system was designed to support people as individuals (or households) and not as clusters or places on the map. Moreover, that design reflects important differences across state and local governments. State governments that believe in more redistribution tend to get more redistribution; state governments that do not believe in redistribution tend to leave people to fend for themselves. In this sense, state sovereignty and democratic legitimacy are powerful influences even when the ‘states’ in question are U.S. states rather than national states (or Member States).

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by Erik Jones

Countries Do Not Borrow, They Are Bought

A lot of the criticism of peripheral countries in the euro area relies on an implicit comparison with households or firms. The argument goes like this: these countries borrowed excessively after they joined the euro at the end of the 1990s in order to live beyond their means and then got in trouble when they could not pay back the money. This argument is usually directed at the public sector in countries like Greece and Italy, at the private sector in Ireland and Spain, and at both the public and private sector in Portugal. These countries have all received their comeuppance and–like any firm or household in a similar situation–they now have to live within their means.

This analogy between countries on the one hand, and households or firms on the other hand, is misleading if not completely wrong. The reason is that countries do not ‘borrow’ in any conventional meaning of the term–at least not under normal circumstances. When things are going well, countries do not fill out an application with various lenders. They do not have to provide a business plan or show any bank statements. They do not offer up collateral or enlist the support of co-signers. These things only take place once a country gets into trouble and needs some kind of international bailout. ‘Borrowing’ for countries in a conventional sense means that something bad has already happened; it is the symptom and not the cause.

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by Erik Jones

Sustainable Integration as a Reponse to Mario Draghi’s ‘Imperfect’, ‘Fragile’ and ‘Vulnerable’ Union

When Mario Draghi was asked on Thursday (16 July) whether the recent crisis surrounding Greece had made the monetary union more vulnerable, he gave an astonishingly frank response. Draghi denied that the discussion about Greece made the union more vulnerable; nevertheless, he admitted that:

this union is imperfect. And being imperfect, is fragile, is vulnerable, and doesn’t deliver all the benefits that it could if it were to be completed. So the future now should see decisive steps on further integration.

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by Erik Jones

Rationality, Emotion, and the Future of Europe

This is a big weekend in the history of European integration and it is likely to be a defining moment for ‘Europe’. That significance is easy to miss. The urgent often overshadows the important. And this weekend reeks of urgency. The Greek government has listed the reforms it can deliver in exchange for financial rescue. It has also described how it would like that rescue to unfold. Now the Eurogroup has to decide whether these proposals are sufficient for the start of fresh negotiations. In doing so, Europe’s politicians have to wrestle with arguments rooted in rationality and emotion; they have to weigh the costs and benefits of yet another Greek bailout package while at the same time dealing with the frustration and bitterness that arose during the last set of talks (not to mention the last five years of bailouts).

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by Erik Jones

The Choice for Europe

The Greek referendum has left the Governing Council of the European Central Bank (ECB) with a political choice that it should not have to make. The ECB will need cover from Europe’s political leaders no matter how this plays out. As with most important choices, this one will make some people very unhappy. We should expect to see opposition emerge both in the media and in the courts. Worse, the choice that the ECB has to make will unfold in stages. It involves a series of decisions and not a simple one-off commitment. That means Europe’s political leaders will have to insulate its central bankers from opposition for the foreseeable future and probably until long after the immediate crisis has passed. Finally, this is a choice that will define Europe’s future; not only will it tell us precisely what it means to be a member of the euro as a single currency, but it will also set a precedent for how much solidarity national governments should expect to receive and to offer.

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by Erik Jones

Broken Europe

The Greek referendum is postmodern and I don’t mean that in a good way. The question is an ‘empty signifier’. No one can understand its literal meaning and that literal meaning is no longer relevant in any case. So you can think of referendum as a big symbol that you can fill with whatever you want; hopes, aspirations, worries, and disappointments all fit in nicely. Moreover, there is no reason any one person has to interpret the question in the same way as anyone else. On the contrary, politicians will try anything to find a hook that will pull you to their side of the issue. No wonder Greek society is evenly (if deeply) divided. Is the glass half full or half empty? Is it really a ‘glass’? What is ‘it’? Even the response assignments are counter-intuitive. According to the government, you vote ‘no’ to have a brighter future; according to the opposition, you vote ‘yes’ if you fear the unknown. What’s more the process itself is controversial. Greece’s detractors decry this whole exercise as a cynical manipulation; for Greece’s supporters, it is a celebration of democracy.

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