Note: see update below
Paul Krugman has a recent post about how the country of Estonia is apparently pissed at him over his objections to the assertion that Estonia’s austerity-policy has been a stunning success. It’s a fascinating story that holds a number of relevant lessons for the conundrum the globe finds itself in at the moment.
The gist of Krugman’s argument is that the Estonia recovery hasn’t actually been all that great: A 20% drop in GDP from 2007–2009 followed by rebound that’s brought Estonia back up to around 92% of its peak 2007 GDP. While this may be true, the austerity-defenders make the case that this is really all a matter of selective data-manipulation and the government’s austerity policies. Plus, Krugman really pissed off Toomas Hendrik Ilves, the president of Estonia. And, apparently, a lot of the rest of Estonia:
Krugmenistan vs. Estonia
By Brendan Greeley on July 20, 2012
In May 2009, months after the passage of a $787 billion stimulus package in the U.S., Estonia’s government took the opposite tack: the hard line. It did not dip into the country’s reserves or borrow money. Ministers say they never even considered devaluing what was then Estonia’s currency, the kroon, which would have derailed a 10-year plan to adopt the euro. To maintain the country’s balanced budget, a tradition it had honored since the end of the Soviet occupation, Estonia’s government froze pensions, lowered state salaries by about 10 percent, and raised the value-added tax by 2 percent. The gross domestic product dropped more than 14 percent that year.
On June 6, in a blog post titled “Estonian Rhapsody,” Krugman took on what he called “the poster child for austerity defenders.” In his post, he graphed real GDP from the height of the boom to the first quarter of this year to show that, even after a recovery, Estonia’s economy is still almost 10 percent below its peak in 2007. “This,” he wrote, “is what passes for economic triumph?”
“It was like an attack on Estonian people,” says Palmik, in an office above his plant, surrounded by blueprints for his new production line. “These times have been very difficult. People have kept together. And this Krugman took all these facts that he wanted.”
Over the course of a week’s visit to three cities in Estonia, I met only two people who didn’t know what Krugman wrote about their recovery. This is not because Estonia is a country of blog-obsessed amateur economists. It’s because Toomas Hendrik Ilves picked a fight.
Ilves is the president of Estonia. The night Krugman wrote his post, Ilves was in Riga, on a state visit to Latvia. He gave a talk to the city’s business community, offering what he calls “moral support” for Latvia’s own austerity policy. He went to a reception on a boat, then returned to his hotel and pulled out his iPhone. “I read somewhere ‘Krugman attacks Estonia,’ and I thought, well, let’s look at his blog,” says Ilves. “I said ‘What the f …’” Ilves does not complete the word.
Estonia’s president has little formal power. As in the U.K., the prime minister runs the government. Like the Queen of England, Ilves has only a bully pulpit. On June 6, standing in front of the Riga Radisson, he linked to Krugman’s post and wrote five tweets in 73 minutes.
8:57 p.m. Let’s write about something we know nothing about & be smug, overbearing & patronizing: after all, they’re just wogs
9:06 p.m. Guess a Nobel in trade means you can pontificate on fiscal matters & declare my country a “wasteland.” Must be a Princeton vs Columbia thing
9:15 p.m. But yes, what do we know? We’re just dumb & silly East Europeans. Unenlightened. Someday we too will understand. Nostra culpa.
9:32 p.m. Let’s sh*t on East Europeans: their English is bad, won’t respond & actually do what they’ve agreed to & reelect govts that are responsible.
10:10 p.m. Chill. Just because my country’s policy runs against the Received Wisdom & I object doesn’t mean y’all gotta follow me.
The tweets made the Estonian papers and the international press. The next morning Jürgen Ligi, the country’s finance minister since 2009, had to comment on them at a press conference. “Maybe the style can be argued,” he tells me. “For example, the reaction was really sensitive, blaming Krugman, but the general idea was right. Krugman was clearly wrong. He clearly doesn’t understand differences of choices between America and in a small economy. By a Nobelist, it was a shame.”
Since independence, Estonia has focused on becoming part of the West. It joined NATO, the Coalition of the Willing, and the European Union. Mart Laar, Estonia’s first post-Soviet prime minister, likes to say that when he was elected, he had read only one book on economics, Milton Friedman’s Free to Choose. The country is open, efficient, and wired. On the World Bank’s Ease of Doing Business Index, it ranks 24th out of 183. Estonia speaks a language close to Finnish, and its strongest trade ties are with Finland and Sweden. At the Kadriorg, Ilves produces a colored map ranking the most competitive economies in the European Union. Estonia sits in the second tier, behind the Nordic countries, grouped with Germany and the United Kingdom.
Note that Estonia isn’t the the only former Eastern-Bloc country to embrace laissez-faire economics with a fervor in the last two decades. According to this piece by George Mason University professor Peter Boettke, the writings of economist Milton Friedman played a role in the collapse of the Soviet Union. Now, since Boettke is Boettke is an Austrian-school economist and director of the Koch-founded/funded Mercatus Center, we shouldn’t be surprised by the Friedman-oriented enthusiasm. Ok, we should be kind of surprised. But generally speaking, think of Friedman as the leader of right-wing “Chicago School” counter-attack against Keynesianism in the latter half of the 20th century (and you can think of the Austrian School as the crazy aunt living in the attic that went mad from her gold obsession).
Skipping down in the article...
Ilves divides Europe into countries that follow the rules and countries that don’t. And he has started worrying about a new kind of populism in Europe: people who play by the rules and are unwilling to help those who didn’t. Ilves points to Finland, where the True Finns party has won votes by rejecting bailouts, and to Slovakia, where the prime minister lost a confidence vote last year for her support of Europe’s bailout fund.
Estonians, in their own eyes, have always followed the rules, and in 2009 took their lumps to do so. Ilves says Estonia’s average salary is 10 percent below the minimum salary in Greece. He says pensions are also much lower, and civil servants retire 15 years later. “You can imagine why there might be some frustration,” Ilves says.
The point made by Estonia’s president about the frustrations Estonians feel over the perceived unfairness of the eurozone bailouts is a critical aspect the entire eurozone crisis, and the Estonians aren’t the only ones that share this sense of resentment. They did indeed “take their lumps”, voluntarily. All three Baltic nations were still issuing their own currencies when the crisis hit (Estonia joined the euro in 2011), and so all three had the option of devaluing their currencies instead of embracing the “internal devaluation”/austerity approach. All three of the “Baltic Tigers” choose austerity and it hurt. A lot. In addition Latvia and Lithuania both had national debts under 20% of their GDP debt and Estonia has had a balanced budget for two decades and almost no public debt at all. Humans are wired to perceive and dislike inequality. Researchers were apparently able to instigate a strike in a capuchin monkey community simply by shifting from a fair to unfair rewards system. We’re wired to perceived unfairness. It makes us tricky critters to rule: we can sense injustice.
The sentiment that “we took our lumps for our success and now you’re asking us to bailout a bunch of layabouts!?” is a very real sentiment across much of EU right now and it’s understandable. And since the Baltic tigers have seen their economies rebound in the last couple of years after swallowing the bitter pill of wage cuts, there’s also the understandable sentiment that the eurozone’s ailing economies (the PIIGS) should simply learn the lessons of the success of the Baltic states’ experiment with crash course austerity. Unfortunately, even when a populace pays dearly in terms of austerity the lessons drawn from their collective experiences may not be entirely applicable to a neighboring nation also undergoing an economic crisis. Many of the same lessons that apply in the Baltics may also apply in the distressed economics of Spain and Italy too. But a lot lessons don’t apply across different economies. So the “we’ve paid, so should they”, sentiment is both an understandable statement, but also a misguided sentiment. Understandably misguided sentiments are a big part of contemporary politics and policy-making:
Myths and truths of the Baltic austerity model
June 28, 2012 12:16 pm by Neil Buckley
Latvia and its Baltic neighbours Estonia and Lithuania suffered the world’s steepest economic contractions in 2009 amid swingeing austerity measures. But now they find themselves in the frontline of the debate over austerity versus growth as the best way to tackle the eurozone’s debt problems.
Even before Ms Lagarde’s comments, the Baltics were the talk of the economic blogosphere after a spat between Paul Krugman, the Nobel economics laureate and austerity critic, and Estonian president Toomas Ilves.
Ilves called Krugman “smug, overbearing and patronising” on twitter after a Krugman blog questioned whether Estonia’s “incomplete” bounceback from a Depression-level slump should be considered an “economic triumph”.
So are the Baltics really a model for, say, Greece or Spain? The answer is probably not – though they may provide lessons. And that makes the Baltic states’ achievements no less extraordinary.
The three former Soviet states binged on cheap capital in the 2000s, hoping to narrow the economic gap with western Europe in double-quick time. They became heavily reliant on short-term external financing. When Lehman Brothers’ collapse cut off international liquidity, their economies – and tax revenues – hit the wall.
Competitiveness, meanwhile, had been sharply eroded by hefty pre-crisis wage increases. All three had also pegged their currencies to the euro. They were desperate to avoid a monetary devaluation, torpedoing their chances of joining the single currency.
So they pioneered the “internal” devaluation – lowering real wages and costs – that Germany, in particular, is prescribing for wayward eurozone economies. They slashed public sector spending, wages and jobs, while carrying out structural reforms.
Consumption collapsed. Latvia, the most extreme case – and the only Baltic country to receive an IMF bailout – saw its economy contract, peak to trough, by a quarter, and by 18 per cent in 2009 alone. Unemployment tripled in three years to 21 per cent. Lithuania’s economy shrank nearly 15 per cent in 2009, Estonia’s 14 per cent.
But all three returned to growth during 2010, and last year Estonia’s 7.6 per cent, Lithuania’s 5.8 per cent and Latvia’s 5.5 were the fastest growth rates among EU economies.
This recovery appears more than a “dead cat bounce”, instead reflecting a genuine recovery in competitiveness. From spring 2010 to autumn 2011, the three saw year-on-year growth in total exports running at above 20 per cent. Estonia and Lithuania experienced peak export growth of a stunning 45 per cent in the first quarter of 2011, notes Anders Aslund of the Peterson Institute for International Economics.
But the Baltics’ experience may not be transferable, or entirely relevant, to eurozone periphery countries.
First, the Baltics were not, like Greece, struggling under a mountain of debt – which their big falls in GDP would have made, proportionally, an even bigger burden. Each had government debt below 20 per cent of GDP in 2008 – Estonia’s was in low single digits.
The Baltic states also experienced far more explosive pre-crisis growth than, say, Greece. In 2005–2007, Latvia’s economy grew by a third; salaries doubled. The economic crash took it back only to 2005.
Unions, too, are much weaker than in, say, Greece. That made street protests against spending cuts, thought not entirely absent, much more muted.
And finally, emigration has played a huge role as a safety valve. Latvia’s population has shrunk about 10 per cent since 2000, to 2m. True, people were seeking better-paid jobs abroad even during the pre-2008 boom. But Mihails Hazans, Latvia’s biggest expert on the subject, says emigration rose sharply after austerity was launched, and increasingly involved entire families. Some estimates suggest Lithuania’s population has declined by at least as much.
As the above excerpt indicates, there are a number of differences between the economic situation facing the Baltic states and the PIIGS but it’s important to keep in mind that nearly ALL the of the EU’s ailing economies had number of big things in common. For starters, they nearly all had a major housing boom (Portugal being an exception). And it was a housing boom that fueled a private — not public — debt binge in the years leading up to the financial meltdown:
Krugmenistan vs. Estonia
By Brendan Greeley on July 20, 2012
In the 1990s, Estonia’s labor costs were low, and the workforce was skilled and educated, so the Finns moved south and started businesses. In a way, Estonia was Finland’s East Germany—close, cheap, and culturally familiar. Around 2004, Swedish and Finnish banks began to compete aggressively to sell mortgages in Estonia, and Estonians began to build new houses. Varblane lists what he calls the “dreadful developments” of the boom years. Private debt increased from 10 percent to 100 percent of GDP. As debt flowed into the country, workers left manufacturing for more lucrative jobs in construction. Wages grew rapidly, and productivity growth flattened out. Manufacturing became more expensive. Domestic debt began to crowd out foreign investment.
The crash was necessary, says Finance Minister Ligi, “to correct our understanding about growth potential.”
It’s interesting to note that the countries with the highest rates of home ownership in Europe tend to be amongst the poorest nations and vice versa. Keep in mind that the housing bust didn’t just wipe out the private wealth of Europe’s poorest nations. It was also the catalyst for the subsequent spike in public debt. It was classic housing bubble in action: as the construction of new houses freezes and existing home values fall a nation won’t find itself only with collapsing tax base. But there’s also the bailouts. Bubbles pretty much always involve excessive lending by the banks. So when that bubble bursts, homeowners and speculative investors default on their loans. And when enough borrowers default, the banks default...at least if it’s a smaller bank. If the bank is BIG enough (i.e. too-big-to-fail BIG), it’s gets bailed out. And THAT’S REALLY EXPENSIVE.
So have the Baltics followed this strange dynamic of a private-sector/debt-fueled boom and bust? In addition to the self-imposed austerity measures, did the Baltic nations also have banking crises following their housing crashes that lead to a public bailout of their banks? Was an experience like that part of what’s led to resentment in the Baltic nations over the ongoing bailouts in the PIIGS? Well...sort of:
Estonia avoided a crisis with its banking system in large part because its banking system “is mostly dominated by Nordic banks”, and the Nordic banks are doing just fine. Mostly. So while private debt levels are still high relative to the low per-capita incomes, the Estonian banking system isn’t facing a risk of insolvency because that system is, in effect, a subsidiary of the Nordic banks.
Lithuania and Latvia also have banking systems dominated by their Nordic neighbors, but they haven’t been quite as fortunate as Estonia. In December 2008, Latvia received a 7.5 billion euro “bailout” in the form of an emergency loan with lots of austere-strings attached. This was following a run on the nation’s second largest bank, Parex, the prior month. The run was only quelled after the Latvian government stepped in and purchased a 51% share in the bank and assumed it(and did some other stuff). In 2009, Parex got a second round of “state capital injections”.
In December last year both Lithuania and Lativa got to experience a new bank run. Or, more precisely, an ATM-run. This was following the collapse and state takeover of Lithuania’s 5th largest bank, Snoras, and its Latvian subsidiary. The cost of this bailout, 1 billion euros, is enough to raise Lithunia’s public debt from 33% to 40% of GDP. And the cause of this collapse? Good ol’ bad ol’ greed and fraud perpetrated by a constellation of foreign and domestic oligarchs.
So the Baltic states are very much in a position to understand how much it sucks to have to bail out a bunch of banks that made fortunes in the build up of the bubble and/or fraud. Its understandable that there might be an expectation that other countries ALSO bail out their banks using public debt. Anything else would be unfair.
Now, if the Baltic Tigers had to endure years of austerity while also footing the bill for the bailout of private banks, why shouldn’t the same be asked of the PIIGS? It’s a reasonable question for austerity-weary members of the public to ask, even if its coupled to an unreasonable demand. So why shouldn’t the PIIGS also just shrink their economies through “internal devaluation”(austerity) and export their way back to economic health? Well, this gets us back to some of the main similarities and differences between the situations facing a nation like Estonia and, say, Spain and Italy.
First, the similarities: The Baltic nations may have still had their own currencies when the crisis hit (recall that Estonia didn’t join the euro until last year), but their currencies were/are being pegged to the euro as a prerequisite for eventually joining the euro. Similarly, the PIIGS are all eurozone members. So Baltic Tigers and the PIIGS all shared the same underlying currency and the same conundrum of being unable to devalue their currencies in the face of a crisis. And currency devaluation is one of the basic tools in the financial-crisis toolbox. All of the countries we’re talking about lack that basic tool. Similarly, all of the countries in question lack a second primary tool that normally exists for countries with a central bank: the ability to simply print more money. Newly created printed money can be invaluable in the midst of an economic crisis. It can finance emergency stimulus spending via the ind, it can buy up government debt...generically speaking, the ability of a central bank to print create more money simply allows a government to do something in an emergency. But this isn’t an option for the eurozone members or those aspiring to join the eurozone. Similarly, instead of printing more money a government could just borrow more and spend it on a stimulus. But if you’re a member of the the eurozone (or an aspiring member like the Baltics), that option is simply no longer there. This is why the “internal devaluation”/austerity protocol that the Baltic Tigers committed themselves to in the wake of their housing bubbles sort of seemed like the default option for the entire eurozone: once you take the option of printing new money, borrowing more, stimulus spending, and currency devaluation off the table, austerity really is one of the only options left.
Now, obviously, an economy can’t just print its way to prosperity. Part of the reason the eurozone’s top policy-makers are so adamantly opposed to the non-austerity path out crisis for the PIIGS is because the only central bank that could print that new money is the European Central Bank (ECB). All of the individual eurozone nations still have their own central banks, but they can’t just print new euros. Only the ECB can do that. And the ECB was set up with strict controls on how much it could expand the money supply. Now why would the eurozone members have done such a strange thing? Well, in large part its because the eurozone’s most influential member, Germany, has a powerful national memory of how out of control government money creation led to hyperinflation in the 1920’s and the subsequent horrors of the 1930’s. Granted, historians actually point towards the deflationary policies of the 30’s as the real catalyst of the economic calamity of the early 30’s that led to the rise of Hitler, but memory can be a weird thing. As is the case with the Baltics, this hyperfear of hyperinflation may be a misunderstanding, but it’s an understandable misunderstanding.
Of course, other than printing more money or “internal devaluation”, there’s also the option an external bailout. It’s a familiar scenario at this point: call the IMF, ask for a bailout, get bailed out but with a bunch of austerity measures and privatizations of state assets as part of the agreement (e.g. “structural reform”), and declare success. It’s pretty much the template for the eurozone bailouts and that shouldn’t be a surprise since the IMF is one third of the “troikas” we now find running running Greece, Ireland, and Portugal. And, of course, a county can find itself in a situation where it can print more money, devalue the currency, get an IMF bailout, and still end up defaulting. It’s a situation Russia found itself in back in 1998, with a number of relevant lessons for today:
The Euro in 2010 Feels Like the Ruble in 1998
By ANDREW E. KRAMER
Published: May 12, 2010
MOSCOW — As the financial markets try to absorb news of a rescue package for Greece and other teetering euro-zone economies, some bankers and economists see parallels to Russia’s default in 1998.
A decade ago Russia was walking in the same shoes as Greece is today, striving to restore confidence in government bonds by seeking a huge loan from the International Monetary Fund and other lenders. Then, as now, the debt crisis was roiling global financial markets. And hopes were pinned on a bailout — one that in Russia’s case did not work.
“Greece creates a remarkable sense of déjà vu,” Roland Nash, the head of research for Renaissance Capital investment bank in Moscow, wrote in a recent note to investors. The 1998 bailout designed for Russia, in the form of a rescue package offered by the International Monetary Fund, had the effect of forestalling but not preventing Russia’s defaulting on its foreign debt.
During the month between the announced rescue and that default, Russian and Western banks frantically cashed out of short-term debt as it matured, changed the rubles into dollars and spirited the money out of Russia.
The bailout propped up the exchange rate through this process, enriching those bondholders who got out early and leaving the embittered Russian public holding the debt and having to pay back creditors, including the I.M.F. By Aug. 17, 1998, when the government announced a de facto default on Russia’s foreign debt and said it would allow the ruble to float more freely against the dollar, the World Bank and monetary fund had disbursed about $5.1 billion of the bailout money.
Some analysts say that if a similar pattern takes hold in the euro-zone rescue, it could be European taxpayers paying for the bailout while investors in Greek debt are largely made whole.
In Russia’s case, the monetary fund, spurred to action by the Clinton administration’s worries about the political consequences in Russia of a financial collapse, cobbled together an aid package that was enormous by the standards of the day.
The monetary fund and other lenders first proposed $5.6 billion, but then raised it to $22.5 billion, including previous commitments — the equivalent of $29.5 billion in today’s dollars.
In Greece, the fund and European Union initially proposed a bailout of 110 billion euros, or $139 billion, last week. After markets reacted skeptically, European finance ministers met over the weekend and proposed a nearly $1 trillion financial support package for Greece and other weak euro zone economies. They proposed forming an investment fund guaranteed by the governments of richer European Union countries like Germany and France that would also draw on monetary fund money.
With Russia, the successive bailout proposals were quickly judged by the markets as too little, too late — as happened with the Greek crisis before the latest announcement.
“You need speed to put out a forest fire,” Anatoly B. Chubais, who was the lead Russian negotiator with the International Monetary Fund in the 1998 crisis, said in written responses to questions about the Greek bailout.
Edmond S. Phelps, a Nobel laureate and Columbia University economist, in a telephone interview cited a lesson from the 1998 bailout: lenders should announce their highest number as quickly as possible, to keep interest rates down and lower the cost of a bailout. International lenders, he said, need to go in “with all their guns blazing.”
Mr. Nash, in his investor note, wrote that bond investors analyzing the situation in Greece and the other weak southern European economies may be doing what bond investors did during the Russia crisis — sizing up underlying negative financial forces so potent that many investors bet against even the bigger bailout package.
Back then, as now, a global economic crisis had rendered local economies uncompetitive at the existing exchange rates. Russia at the time had pegged the ruble to the dollar, Greece today is locked into the euro zone.
In Russia’s case, the prices for the country’s mainstay petroleum exports had plummeted the previous year because the economic contraction in Asia in 1997 had diminished demand. The ruble was under pressure to follow this trend downward. For many months, though, the Russian central bank kept the ruble pegged to the dollar — a dollar that was gaining strength as global investors sought a safe harbor.
Only after the Russian central bank finally did devalue the ruble in August 1998, which plunged by 70 percent within a month, did the Russian economy begin to recover. The turnaround was faster than anybody imagined. Within a year, Russia’s economy had recovered to precrisis levels and a decade of rapid growth followed. Banks rushed back to do business in Russia.
Russia’s oil woes back then may be analogous to the gap today between Greece’s and Southern Europe’s low productivity and the high salaries its workers receive in euros. But the fix may be harder to achieve.
“Greece, fundamentally, does not have a debt problem,” Mr. Nash wrote. “It has an economy which is not competitive at the prevailing exchange rate and which lacks the structural flexibility to become competitive.”
Yes, Russia, in the end, faced a situation with a number of parallels to what countries like Greece or the Baltics face: a currency pegged to a stronger international standard (the dollar in Russia’s case, the euro EU case) was supposed to give foreigner investors the kind of confidence in the country that would spur long-term investments and a dynamic economy. But when a crisis hits — a housing crash in the EU and the Asian financial crisis of 1997 for Russia — that commitment to an artificially strong currency can become a liability. And those efforts to maintain that artificial strength can end up simply providing the foreign investors a “get out of jail free” card, so to speak. The bailout props up the currency during a time when foreign lenders are all tempted to head for the exits.
As the commentators in the above article pointed out, the management of a financial crisis isn’t simply a matter of technocratic manipulation of this or that interest rate. It’s closer to psychological warfare: the central bank and government in crisis has to convince foreign investors that the whole house of cards isn’t going to burn down. THAT’s why the ability ability of a central bank to print its own money at will and in unlimited amounts is such a sharp double-edge sword: When used appropriately, a central bank can assure markets that there won’t be a “liquidity event”. That’s what happens when the market for something freezes up when, for instance, you have tons of sellers and no buyers. When that happens for a commodity or stock the price tends to plunge in a panic. But when it happens to a government’s sovereign debt market the entire economy freezes. Liquidity events in any of the key markets, like short-term government debt, is how economies die, so the ability/threat of a central bank to print unlimited amounts of cash and use it to buy a critical security (usually government debt) is a very powerful tool to use ward of a liquidity event. But once that spigot really is turned on, it’s not especially easy to turn off and it really can potentially overwhelm a country’s money supply. In other words, you don’t really want to turn on the unlimited-money fire hose unless there’s really a fire. But if you’re going to use that fire hose, use it early and use it overwhelmingly. Russia and the IMF had that fire hose in 1998 but didn’t use it in time and ended up defaulting anyways (a 70% devaluation in their currency within an month was basically a default).
So, if currency devaluation — like Russia dropping the ruble’s currency peg to the dollar — is effectively a default, and defaults are to be avoided at all cost, how does currency devaluation avoid spooking foreign investors? Well, once again, one of the primary jobs (and tools) of a central bank is the management of the psychology of the marketplace. When investors or spooked, central banks are supposed to step in and prevent a panic. When investors get overly exuberant and move into “bubble” territoriy, central banks are supposed to step in and “remove the punch bowl”. And when investors are REALLY spooked over about the long-term viability of a nation’s economy, a central bank’s job is convince investors that there really is a future for this country. Currency devaluation is one of the main tools that can give the world a sense that a country really does have a future. When a country can export again, that light at the end of a tunnel might not look so much like an oncoming train, and nothing helps a country export more than a currency devaluation. Think of the ability of a central bank to print unlimited money as one of the primary tools available for dealing with immediate liquidity crises, whereas the ability to devalue a currency is sort of a long-term solution. In a financial panic, you need both short term AND long term solutions and you need them simultaneously.
Now, if the Baltics were able to rebound successfully (well, ok, that depends on you who ask to define “successfully”), why can’t nations like Spain, and Italy just follow that same model? Well, now we return to the similarities and differences between and economies like Spain and Italy, and one like Estonia. One obvious difference between the two nations is that Spain and Italy are simply much much larger than any of the Baltics. If they’re going to export their way back to health someone else has to buy all those exports. That’s a lot easier to do in tiny economies like the Baltics where much of the economic growth of the past decade involved foreign manufacturers moving in and setting up factories for export. In other words, if you’re already an export-oriented economy, exporting your way back to health is just a lot easier to do. And if you’re a tiny export-oriented economy with wealthy neighbors, it’s that much easier.
Nearly everyone agrees that Spain and Italy need more exports, but can they just “internally devalue” and export to the rest of the world in place of the normal currency-devaluation? Well, in theory, and over a long period of time. Austerity measures could remain, unemployment could languish at high rates and wages could continue to fall. But here’s the problem: unlike a currency devaluation, which sort of has the effect of uniformly bringing down everyone’s wages in a nation (at least with respect to the outside world), “internal devaluation” doesn’t rely a nice smooth mechanism like currency devaluation. Instead, it relies on folks just taking a big pay cut. As many folks as possible. And here’s the problem: wages are “sticky”. Unemployment may rise, but that doesn’t smoothly translate into lower wages. Instead, what we’ve seen in Spain and Italy is simply high unemployment, but with little improvement in overall “competitiveness” because wages haven’t fallen. And neither should we expect them to unless a country submits to some sort of centralized wage authority. That’s just the messiness of real life interfering with economic theory. Even Estonia, a country that consciously embrace “internal devaluation”, wages did eventually fall, but they were still pretty “sticky”:
Krugmenistan vs. Estonia
By Brendan Greeley on July 20, 2012
Krugman was right about one thing: Wages were sticky. But they weren’t glued. They declined slightly in 2009 and 2010. They have grown since, but the larger wage trend since 2007 is flat. Anecdotally, some industries reported wage cuts of as much as 30 percent. Productivity, in the meantime, recovered. And both look roughly where they’d be now had there been no housing boom. As hoped, Estonia’s growth in 2010 and 2011 came from exports. The government points proudly to Ericsson’s (ERIC) recent decision to build a plant near Tallinn. Estonia’s politicians seem relieved that the country has resumed its rightful place in the world: manufacturing, exports, and sobriety.
So why can’t this work for Spain and Italy? Well, it could work...in the long run. Once a country’s spirit and economy is sufficiently broken, those wages will eventually fall. But why can’t this work in the short run? Well, once again, it could...in a different world. More specifically, it could potentially work in a world that had the global demand to buy all those newly competitive Spanish and Italy exports. That’s a very different world from the one we live in today and that brings us to one of the central problems with the entire austerity/“internal devaluation” approach to solving these kinds of sovereign debt crises: “internal devaluation” might increase exports and reduce imports, but it comes at an enormous cost that isn’t nearly as costly when currency devaluation is used instead: “internal devaluation” breaks the internal economy:
Spain is More Competitive than You Think
Jun 18, 2012 1:00 AM EDT
You know Spaniards are depressed when Coca-Cola broadcasts a television commercial encouraging citizens to “go get ’em.” The spot cuts away from foreign commentators predicting Spain’s imminent collapse to showcase the country’s strengths: engineers, high-speed trains, and, of course, soccer. In the midst of a currency crisis, steep credit downgrades, and a 100 billion euro bailout of its banking system, it’s easy to be pessimistic about Spain. But there are some grounds for optimism.
Start with exports. While Spanish wages rose much faster than the euro zone average during the pre-crisis years, large exporters kept costs under control, allowing them to stay relatively competitive. Meanwhile Spanish employers with more than 250 workers stayed just as productive as their German, Italian, and French counterparts, according to BBVA, Spain’s No. 2 bank.
Consequently, despite Asia’s rise, Spain has managed to hang on to its global market share of exports. That puts it in a league with Germany and well ahead of most of the euro zone. Inditex, the apparel group best known for its Zara retail chain, is a poster child of Spanish competitiveness. It shrugged off the European financial crisis and even delivered a sharp rise in first-quarter profits.
The catch is that exports, which account for about 30 percent of Spain’s GDP, can’t compensate for the steep drop in demand at home. Yet some companies are doing well inside Spain. Mercadona, the largest purely domestic grocer, boosted sales by 8 percent last year, to 17.8 billion euros. Its unique business model is studied in the classrooms of top American business schools.
Spain’s emblematic companies show that this can be done. But their success has been despite, not because of, the country’s politicians and rigid employment laws. Spain has already implemented painful reforms, particularly in the labor market, but they will take time to feed into the economy. The bank bailout may eventually ease the ongoing credit crunch, but in the short term the country’s spiraling borrowing costs will make it harder for Spanish entrepreneurs to finance their businesses. In the meantime, the hope in Madrid is that the country’s national soccer team, winner of the last World Cup, will provide some respite from the doom and gloom.
As the above article highlights, one of the fundamental problems with the “internal devaluation” approach is that any boost to exports comes at a pretty significant cost to the internal economy: If the Keynesian solution to a fiscal crisis involves more inflation (in the form of currency devaluation and more public debt), the “austerion” solution is more unemployment. And in the inflation vs unemployment debate, the unemployment approach rarely seems to work. One of the main reasons the economic rebound of the Baltic nations has been pointed out as an exceptional example of the power of austerity is because success with austerity alone is exceptionally rare. It just doesn’t help a country to break its non-export-oriented economy. This is partly do to fact that sovereign debt crisis are virtually never only about long-term concerns over the economic viability of a nation. There is always a short-term component to the crisis, and the closer a nation gets to default the greater those short-term concerns become in the minds of international investors. And if there’s one thing those international investors don’t want to see in a country facing a debt crisis it’s a surge in debt coupled with a collapse in confidence. Remember, central banking is as much about waging psychological warfare as it is a task of managing the economy. If a surge in debt is used in a large pro-stimulus manner that creates real confidence that the government is serious about addressing the economic problems both in the short, medium, and long-run, the markets will be willing to accept that surge in debt and a crisis can be averted. But if a surge in debt is taking place amidst austerity measures due to a collapsing internal economy AND this is all taking place in a collapsing international economy...well, that’s just a recipe for disaster. Exactly the kind of disaster we’ve been seeing across the eurozone. Austerity is, at best, a long-run solution. Financial panics are short-term traps that may or may not involve long-term concerns. But regardless of whether or not long-term “competitiveness” concerns are part of what’s driving the panic, any solution that requires long-term patience on the part of international investors is pretty much doomed to fail.
So why is Germany, leader of the eurozone, so adamant about austerity as the only model? Well, partly because Germany tried austerity less than a decade ago and it worked...sort of. Germany may have implemented its own version of austerity/“internal devaluation” in 2005, but that’s also not a great example of the value of austerity in the midst of a sovereign debt crisis. Germany wasn’t in the midst of financial panic and the global economy was still growing...it was a very different situation from what Spain and Italy find themselves in today (Plus, the Germans had some “help” that cushioned the blow). But it’s also important to keep in mind that the wage cuts experienced German workers in the mid 2000’s were real and painful. One again, the desires of the German public to see the PIIGS pay for their bailout might be misguided, but it’s understandably misguided. But that just explains the mass psychology of the general public. The behavior of Germany’s politicians, on the other hand, is less understandable. It’s actually pretty perplexing:
The Irish Times — Friday, July 20, 2012
Bundestag gives backing for bailout of Spanish banks
DEREK SCALLY in Berlin
GERMAN FINANCE minister Wolfgang Schäuble will add Berlin’s support for bailing out Spanish banks today after receiving the backing of a large Bundestag majority yesterday evening.
Some 473 MPs voted in favour of contributing almost €30 billion in German loans and guarantees to the Spanish package of up to €100 billion, running over 18 months.
But opposition was more marked than in previous bailout votes: some 97 of a total of 620 MPs opposed the move, including 22 from the coalition ranks, with a total of 13 abstentions.
The government failed to get an absolute, so-called “chancellor” majority, though six coalition politicians were missing from the midsummer parliamentary recall.
Before the vote, Mr Schäuble said financial markets had “doubts” about Spain’s economic health and the bailout would help Madrid buy time to complete cutbacks and reforms already under way.
“Spain is on the right path to solid state finances but this progress is endangered by insecurity over its financial sector,” he said.
“We have a strong interest in allowing Spain to continue to reform.”
He assured MPs that full liability for all loans lay with the Spanish state, dismissing speculation in some quarters that recapitalising euro zone banks would let states off the hook for liability.
Mr Schäuble denied this was the case with the Spain bailout, insisting European leaders would discuss this issue only after a European banking regulator was in place and operating to everyone’s satisfaction.
“Anyone who talks about immediate, direct refinancing of banks through the ESM (bailout fund) or of collective liability for banks in the euro system is shooting his mouth off,” he said, a dig at euro zone bailout chief Klaus Regling.
Opposition leader Frank Walter Steinmeier, parliamentary head of the Social Democrats (SPD), said his party would support the bailout for euro zone stability – but as a show of support for the euro zone and not for the government.
He accused Angela Merkel’s coalition of unsettling voters by spinning a “fairy tale” of fiscally prudent Germans surrounded by fiscally reckless neighbours.
“Germany is no blessed isle. The crisis will hit even export-driven countries [such as Germany] and, as one export market after another hits the skids, we cannot rule out that we will be dragged down,” he said.
Mr Steinmeier put the government on notice that the SPD would not continue to support euro zone bailouts for banks unless creditor involvement was agreed.
OK, first off, kudos to SPD leader Frank Steinmeier. By calling out Merkel for selling German voters on a fairy tale of “lazy Southerners” we might be seeing a sign that the power of the politics of perceived inequality is fading in Germany. Now let’s hope the same happens in Finland. Soon. Far-right political gains aren’t just being seen in the crisis-hit eurozone members. Finland, with one of the strongest economies in europe, saw the far-right True Finns party surge to 19% of the vote in last year’s elections based on anti-bailout sentiment. And that sentiment hasn’t subsided since then as the southern economies continue to erode. In fact, Finland managed to extract a special concession in exchange for its support of the latest Spanish bank bailout: collateral values at ~40% of its share of the loans to Spains banks. The synergistic relationship between the eurozone crisis and the rise of radical political groups is a growing and most troubling phenomena.
So what are we seeing here with the German parliament demanding that Spain’s public accept the full liability for a 100 billion euro bailout of Spain’s banks? Isn’t that just going to exacerbate the underlying sovereign debt crisis? Well yes, but we’re not just seeing the politics of bailout-resentment on display here. One way to look at it is we’re seeing an attempt to do the unprecedented: central banking doesn’t really have precedent for dealing with financial panics using the austerity-only approach. The accepted paradigm for quelling a panic is for the central bank to act as a “lender of last resort”. In other words, the central bank needs to threaten to do whatever it can to stop the panic. Stimulus spending, buying debt, printing money, anything. It may not be a perfect approach but it does have a track record of working. But in our brave new world of the eurozone, the only central bank in the eurozone with the power to buy bonds and issue euros is the ECB. And not only does the ECB not want to use its power of lender of last resort. It’s mandated to do one thing only: maintain “price-stability”. That’s a fancy way of saying “avoid inflation at all costs”. Deflation is fine, though...you can’t have “internal devaluation” without deflation. And the special funds set up to help “bailout” the PIIGS (the EFSF and the ESM) can’t actually buy sovereign debt themselves. At least not unlimited amounts. Only the ECB could technically engage in these activities and be a “lender of last resort” but it’s mandated not to do so:
Thursday, July 5, 2012
Marshall Auerback: All Roads Lead to the ECB
By Marshall Auerback, a hedge fund manager and portfolio strategist. Cross posted from New Economic Perspectives
We’ve always been a fan of Professor Paul De Grauwe from University of Leuven, who has consistently pointed out the structural flaws inherent in the original structures of the EU. Recently, Professor de Grauwe wrote an excellent analysis explaining why the latest “rescue plan” cobbled together by the Eurozone authorities is destined to fail.
The key points:
1) ECB is not currently a ‘lender of last resort’. The ECB was set up with fundamental flaws, where “… one of the ECB’s main concerns is the defense of its balance sheet quality. That is, a concern about avoiding losses and showing positive equity– even if that leads to financial instability.” This is a profoundly misconceived idea. As we have noted many times, a private bank needs capital – clearly because there are prudential regulations requiring that – but because it can become insolvent. It has not currency-issuing capacity in its own right. While the ECB has an elaborate formula for determining how capital is from the national member banks at an intrinsic level, it has no need for capital. It could operate forever with a balance sheet that if held by a private bank would signal insolvency. There are no comparable concepts for a currency issuer and a currency user in terms of solvency. The latter is always at risk of insolvency the former never, so the ECB’s focus on profitability is not only misguided, but leading to inadequate policy responses.
2) The creation of the European Financial Stability Facility (EFSF) and the ESM has been motivated by the overriding concern of the ECB to protect its balance sheet and to avoid engaging in “fiscal policy”. The problem again goes back to the creation of the euro: no supranational fiscal authority to go with a supranational central bank, which means that the only entity that can conceivably carry out “fiscal transfers” of the sort exemplified by a bond buying operation is the ECB. Sure, the actual fiscal transfers can be ’subcontracted” to the EFSF and ultimately the ESM, but it can only work if the latter’s balance sheet is linked to the ECB’s, giving it the same unlimited capacity to buy up the bonds and thereby deal with the insolvency issue. As things stand now, per de Grauwe: “The enlarged responsibilities that are now given to the ESM are to be seen as a cover-up of the failure of the ECB to take up its responsibility of the guardian of financial stability in the Eurozone; a responsibility that only the ECB can fulfill”.
3) Related to this problem is the fact that the ESM has been given only finite resources as per Germany’s stipulation the minute it begins. It is capitalised at 500bn euros. And it’s unclear that Germany can go much further, given that there are currently 3 constitutional challenges which the ESM is now facing within Germany’s courts. This will delay ratification of the vote taken last week by Germany’s parliament to ratify the ESM’s existence, as well as limiting its firepower going forward. The ESM’s “bazooka” is in effect a pop-gun. Consequently, as de Grauwe argues, “Investors will start forecasting the moment when the ESM will run out of cash. They will then do what one expects from clever people. They will sell bonds now rather than later.”
As is clear from every FX crisis in the past, “A central bank that pegs the exchange rate and has a finite stock of international reserves to defend its currency against speculative attacks faces the same problem. At some point, the stock of reserves is depleted and the central bank has to stop defending the currency. Speculators do not wait for that moment to happen. They set in motion their speculative sales of the currency much before the moment of depletion, triggering a self-fulfilling crisis. “
Until Europe’s authorities have this figured out, the crisis will continue. All roads lead back to the ECB.
Once again, the ECB simply isn’t allowed do what the Federal Reserve of Bank of Japan can do because the ECB’s mandate is limited to one thing: “price stability”. Fighting inflation is pretty much it’s one and only priority. And not surprisingly, that’s also the only mandate of the Bundesbank. As the Bundesbank goes, so goes the ECB. The nightmare of the Weimar Republic lives on, but in reverse and in neighboring countries.
So what is this new paradigm that we’re seeing here? What is the lesson for the world that the ECB (Bundesbank) has in store for the rest of us? Well, in some ways this an unprecedented approach to central banking and economic management. In other ways it’s old school. Austrian old school:
The Hangover Theory
Are recessions the inevitable payback for good times?
By Paul Krugman|Posted Friday, Dec. 4, 1998, at 3:30 AM ET
A few weeks ago, a journalist devoted a substantial part of a profile of yours truly to my failure to pay due attention to the “Austrian theory” of the business cycle—a theory that I regard as being about as worthy of serious study as the phlogiston theory of fire. Oh well. But the incident set me thinking—not so much about that particular theory as about the general worldview behind it. Call it the overinvestment theory of recessions, or “liquidationism,” or just call it the “hangover theory.” It is the idea that slumps are the price we pay for booms, that the suffering the economy experiences during a recession is a necessary punishment for the excesses of the previous expansion.
The hangover theory is perversely seductive—not because it offers an easy way out, but because it doesn’t. It turns the wiggles on our charts into a morality play, a tale of hubris and downfall. And it offers adherents the special pleasure of dispensing painful advice with a clear conscience, secure in the belief that they are not heartless but merely practicing tough love.
Powerful as these seductions may be, they must be resisted—for the hangover theory is disastrously wrongheaded. Recessions are not necessary consequences of booms. They can and should be fought, not with austerity but with liberality—with policies that encourage people to spend more, not less. Nor is this merely an academic argument: The hangover theory can do real harm. Liquidationist views played an important role in the spread of the Great Depression—with Austrian theorists such as Friedrich von Hayek and Joseph Schumpeter strenuously arguing, in the very depths of that depression, against any attempt to restore “sham” prosperity by expanding credit and the money supply. And these same views are doing their bit to inhibit recovery in the world’s depressed economies at this very moment.
The many variants of the hangover theory all go something like this: In the beginning, an investment boom gets out of hand. Maybe excessive money creation or reckless bank lending drives it, maybe it is simply a matter of irrational exuberance on the part of entrepreneurs. Whatever the reason, all that investment leads to the creation of too much capacity—of factories that cannot find markets, of office buildings that cannot find tenants. Since construction projects take time to complete, however, the boom can proceed for a while before its unsoundness becomes apparent. Eventually, however, reality strikes—investors go bust and investment spending collapses. The result is a slump whose depth is in proportion to the previous excesses. Moreover, that slump is part of the necessary healing process: The excess capacity gets worked off, prices and wages fall from their excessive boom levels, and only then is the economy ready to recover.
Except for that last bit about the virtues of recessions, this is not a bad story about investment cycles. Anyone who has watched the ups and downs of, say, Boston’s real estate market over the past 20 years can tell you that episodes in which overoptimism and overbuilding are followed by a bleary-eyed morning after are very much a part of real life. But let’s ask a seemingly silly question: Why should the ups and downs of investment demand lead to ups and downs in the economy as a whole? Don’t say that it’s obvious—although investment cycles clearly are associated with economywide recessions and recoveries in practice, a theory is supposed to explain observed correlations, not just assume them. And in fact the key to the Keynesian revolution in economic thought—a revolution that made hangover theory in general and Austrian theory in particular as obsolete as epicycles—was John Maynard Keynes’ realization that the crucial question was not why investment demand sometimes declines, but why such declines cause the whole economy to slump.
Here’s the problem: As a matter of simple arithmetic, total spending in the economy is necessarily equal to total income (every sale is also a purchase, and vice versa). So if people decide to spend less on investment goods, doesn’t that mean that they must be deciding to spend more on consumption goods—implying that an investment slump should always be accompanied by a corresponding consumption boom? And if so why should there be a rise in unemployment?
Most modern hangover theorists probably don’t even realize this is a problem for their story. Nor did those supposedly deep Austrian theorists answer the riddle. The best that von Hayek or Schumpeter could come up with was the vague suggestion that unemployment was a frictional problem created as the economy transferred workers from a bloated investment goods sector back to the production of consumer goods. (Hence their opposition to any attempt to increase demand: This would leave “part of the work of depression undone,” since mass unemployment was part of the process of “adapting the structure of production.”) But in that case, why doesn’t the investment boom—which presumably requires a transfer of workers in the opposite direction—also generate mass unemployment? And anyway, this story bears little resemblance to what actually happens in a recession, when every industry—not just the investment sector—normally contracts.
As is so often the case in economics (or for that matter in any intellectual endeavor), the explanation of how recessions can happen, though arrived at only after an epic intellectual journey, turns out to be extremely simple. A recession happens when, for whatever reason, a large part of the private sector tries to increase its cash reserves at the same time. Yet, for all its simplicity, the insight that a slump is about an excess demand for money makes nonsense of the whole hangover theory. For if the problem is that collectively people want to hold more money than there is in circulation, why not simply increase the supply of money? You may tell me that it’s not that simple, that during the previous boom businessmen made bad investments and banks made bad loans. Well, fine. Junk the bad investments and write off the bad loans. Why should this require that perfectly good productive capacity be left idle?
The hangover theory, then, turns out to be intellectually incoherent; nobody has managed to explain why bad investments in the past require the unemployment of good workers in the present. Yet the theory has powerful emotional appeal. Usually that appeal is strongest for conservatives, who can’t stand the thought that positive action by governments (let alone—horrors!—printing money) can ever be a good idea. Some libertarians extol the Austrian theory, not because they have really thought that theory through, but because they feel the need for some prestigious alternative to the perceived statist implications of Keynesianism. And some people probably are attracted to Austrianism because they imagine that it devalues the intellectual pretensions of economics professors. But moderates and liberals are not immune to the theory’s seductive charms—especially when it gives them a chance to lecture others on their failings.
Keep in mind that Paul Krugman wrote the above critique of the Austrian School of economics in 1998, a decade before the current crisis. It’s also an amazingly predictive critique. What Krugman wrote about the Austrian approach to economics is pretty much what has happened: a financial crisis was turned into a morality play and the ensuing austerity-policies ended up taking down entire national economies. And with Krugman now the biggest opponent of this neo-Austrian School of economics, it’s no surprised that we end up seeing lots of fanfare over the “Krugmenistan vs Estonia” story. After all, if the ECB was to successfully save the eurozone with austerity alone, that would send a powerful message to all future economies around the globe that austerity works. What’s we’re seeing here isn’t Krugmenistan vs Estonia. It’s Krugmenistan vs Austeria. It’s the ultimate morality play where the final moral of the story is that government social spending doesn’t work and only leads to disaster. We are being taught that central banks shouldn’t step in to act as the lender of last resort. That will only put off the necessary pain required for proper reform. One can see how this is an emotionally compelling approach to macroeconomics. And if you’re looking at the consequences of this approach, one can see how it’s also a giant blunder. An understandable giant blunder, sure, but still a giant blunder. The Austrian School of economics isn’t just a piece of our past: it’s intended to be our future too. Our blunderous future.
So how is the eurozone supposed to proceed forward and not continue on as a giant fiscal trap for its denizens? Well, one approach would be for the ECB to drop the morality play and act like a real central bank. We just got a sign today that the ECB may do just that when ECB head Mario Draghi announced that the ECB is ready to start buying sovereign bonds again. As he put it, “these are not empty words now”. Then again, he also said that the ECB must still act within it’s mandate...the single mandate of fighting inflation. So these may, once again, be empty words. Still, it’s progress.
But ECB bond buying is still only a short-term solution. The eurozone needs a long-term solution and tit-for-tat austerity really isn’t going to cut it. If the eurozone member nations end up viewing each other as either moochers or cruel austerity freaks it’s just not going to work. So here’s a free tip borrowed from a billionaire: the eurozone needs to remember the birth lottery. It’s a simple concept popularized by billionaire Warren Buffett and it’s one most useful best ideas the guy has ever had. Think of it like this: We don’t control where we’re born, who our parents are, what our natural traits might be (physically, IQ, etc), and really much else. At least not until we get older and begin to make our own way in the world. And even once we become adults there is still an immense amount of our world that is well beyond our individual control. So with that in mind, if you were a hypothetical future citizen of the eurozone but you couldn’t control anything about which country you were born in and any of your other natural traits, how would you want that eurozone to be structured?
Here’s a second tip: Part of the Austrian School involves a fixation on the going back to the gold standard. There are a lot of problems with the gold standard, but as is the case with austerity-politics there’s just an immense amount of emotional pull to the idea of a “hard” currency. Now, since humanity is facing an imminent natural resource crisis, perhaps the aspiring Austrian School economists could start focusing their mental efforts on something much more useful: an vital natural resources standard. As they say, you can’t eat gold. Fresh water and top soil, on the other hand, really help with eating. A meaningful natural resources standard would no doubt have a number of problems, but at least it’s not a dead end like gold. We’re all dead in the long run, but humanity is dead if we don’t get this resource crunch under control. That’s real austerity.
Here’s a final tip, although it’s not really for the eurozone. It’s for Mitt Romney. And it’s not really a tip. It’s more of a declaration: Mittens, you have some messed up friends.
Well, I guess we know whether of not the ECB’s recent change of heart is real or not. It’s not:
Bundesbank pours cold water on ECB bond buy hopes
FRANKFURT | Fri Jul 27, 2012 6:38am EDT
(Reuters) — Germany’s Bundesbank dampened expectations for further action by the European Central Bank on Friday by upholding its resistance to the ECB buying bonds, a day after ECB President Mario Draghi raised expectations such a move could be on the cards.
Draghi sent a strong signal to markets on Thursday that the ECB was preparing further policy action, saying that the ECB was ready, within its mandate, to do whatever it takes to preserve the euro, referring also to inflated borrowing costs, which some saw as a hint the bank could revive its bond purchase program.
The Bundesbank, which opposes the ECB’s Securities Markets Program (SMP) because it treads too close to the central bank’s ultimate taboo of state financing, said on Friday it was still not in favor of such a step.
“The Bundesbank continues to view the SMP in a critical fashion,” a Bundesbank spokesman said “The mechanism of bond purchases is problematic because it sets the wrong incentives.”
The ECB has spent more than 210 billion euros on government bonds, having bought them in the secondary market.