Archive for the ‘Euro crisis’ Category

Following up my last post on the eurozone crisis and the monetary policy of the ECB (see IIMR esearch Paper 3: Have Central Banks forgotten about money? by my colleague Tim Congdon and myself), please find below a video with further details on the changes made to the monetary strategy of the ECB since its establishment.

What I claim in the video is that the ECB did give a prominent role to the analysis of the changes in broad money up to 2003, when it reviewed its strategy, and not surprisingly it led to a higher rate of growth of money in the Eurozone in the years running up to the Global Financial Crisis. Just to be clear, I do not support that any central bank should adopt a ‘mechanistic’ monetary growth policy rule, by which the bank adheres to an intermediate M3 (or broad money) rate of growth target come what may. The link between money and prices and nominal income is indeed very strong over the medium and long term, but it is of course affected by other variables/phenomena in the short term that need to be properly considered and taken into account by policy makers. So rather than a mechanistic approach to such a monetary target, changes in money growth should be given a primary role in assessing inflation and nominal income forecasts, and thus in the making of monetary policy decisions; and this is precisely what the ECB did from 1999 to 2003 under its two-pillar strategy. So when money growth continuously exceeds the rate deemed to be compatible with monetary stability, this would signal inflationary pressures and even financial instability the central bank would eventually tackle by tightening its monetary policy. This rationale would show the commitment of the central bank to both monetary and financial stability over the long term, and the use of a broad monetary aggregate would serve as a credible indicator to make monetary policy decisions and as a means to transmit the central bank’s expectations on inflation and output growth.

As ever, comments very welcome.

Juan Castañeda

PS. More videos on the IIMR YouTube channel




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This is the title of a research paper I have written with my colleague and leading monetarist, Professor Tim Congdon, and published by the Institute of International Monetary Research (IIMR). This is a brief summary extracted from the paper, which is fully available at http://www.mv-pt.org/research-papers:

The quantity of money matters in the design of a monetary policy regime, if that regime is to be stable or even viable on a long-term basis. The passage of events in the Eurozone since 1999 has shown, yet again, that excessive money growth leads to both immoderate asset price booms and unsustainably above-trend growth in demand and output, and that big falls in the rate of change in the quantity of money damage asset markets, undermine demand and output, and cause job losses and heavy unemployment. This is nothing new. The ECB did not sustain a consistent strategy towards money growth and banking regulation over its first decade and a half. The abandonment of the broad money reference value in 2003 was followed in short order by three years of unduly high monetary expansion and then, from late 2008, by a plunge in money growth to the lowest rates seen in European countries since the 1930s. The resulting macroeconomic turmoil was of the sort that would be expected by quantity theory- of-money analyses, including such analyses of the USA’s Great Depression as in Friedman and Schwartz’s Monetary History of the United States.

This paper argues, from the experience of the Eurozone after the introduction of the single currency in 1999, that maintaining steady growth of a broadly-defined measure of money is crucial to the achievement of stability in demand and output. The ECB did not sustain a consistent strategy towards money growth and banking regulation over its first decade and a half.

The chart below illustrates our point very well:












As ever, comments very welcome.

Juan Castañeda


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On March 2nd (Fundación Rafael del Pino, Madrid) I had the pleasure to join a panel on the future of the European Banking Union (EBU) (and on Brexit) with very distinguished colleagues and friends: Jose Manuel Gonzalez Paramo (BBVA and former member of the ECB Executive Committee), David Marsh (OMFIF, London) and Pedro Schwartz (UCJC, Madrid) (see the video of the seminar here). During the  event I also had the opportunity to launch in Madrid the book I co-edited last year on the European Banking Union. Prospects and Challenges (Routledge). The book is a collection of essays on the EBU by central banks’ analysts, academics and practitioners from different jurisdictions. Each of them addresses the topic from a different perspective, either legal or economic, and highlights the pros and cons of the EBU as well as its expected challenges over the next few years.

It is obvious to all now, but also to many experts at the time of the launch of the euro, that the institutional architecture of the euro was, at the very least, weak and incomplete (see some of the articles in the 1990s written by W. Buiter, C. Goodhart, P. Schwartz, T. Congdon or G. Wood, amongst others). No currency union has survived for long without a political union or a supranational Treasury, with enough powers and policies to back the currency. And this is particularly true in the case of an area, such as the Euro area, which is far from being a flexible and fully functioning monetary area. You may want to check out the results of the research report just published by the Institute of International Monetary Research on the measurement of the integration of the euro area or its ‘optimality’ as a single currency.

The reference to the classical gold standard (1870s – 1913) as a comparison with the current euro standard deserves some attention. We should be aware of the differences between both standards: the gold standard was indeed a monetary union, where member economies fixed their currencies against gold; whereas the euro standard is a currency union, where countries get rid completely of their national currencies and adopt a single currency for all. The latter is much more rigid and demanding during a crisis, since member states have no room to alter the parity of the currency (there is no national currency!), nor to abandon the parity on a temporary basis. Under a currency union member countries have effectively no central bank of issue, as this function has been fully delegated to a supranational central bank. We have experienced since 2008 how demanding this monetary system becomes under a crisis, much more a severe financial crisis, as countries have no other option but to cut costs and prices in an effort to regain competitiveness (the so-called ‘internal devaluation’). This is an option to sort out the crisis, but it has proven to be a painful one our economies (and even more, our populations) seem not to be ready to implement or even to accept.

In a nutshell, the EBU implies the following (more details on the presentation here):

  • The establishment of the European Banking Authority (EBA), which overseas the implementation of the new (much higher) Basel III banks’ capital ratio and the new liquidity ratio across the EU.
  • The establishment of a single banking regulator under the ‘Single Supervisory Mechanism‘ (SSM) for big banks or transnational banks in the Eurozone (around 80% of all), in the hands of the European Central Bank in Frankfurt. In addition the new Single Resolution Mechanism (SRM) has been stablished to deal with the recovery or resolution of a bank (see more details below).
  • According to the new EU Recovery and Resolution Directive (RRD), every bank must draft a resolution plan to be approved by the regulator, in order to resolve the bank if needed be in an orderly and timely manner. In addition, should a bank under the SSM need to be resolved, the government will not use taxpayers’ money in the first place. Actually the resolution or recovery process is going to be handled by the SRM. And only when the bank’s shareholders and creditors’ money has been (mostly) exhausted (so they have absorbed losses of at least 8% of the total liabilities), the bank can benefit from other sources of funding to pay its debt or conduct other operations (such as the Resolution Fund, see below). This is what the literature calls a bail-in rather than the bail-outs of the banks with taxpayers’  money we have seen in the recent crisis.
  • In addition, all member states have agreed to guarantee the deposits up to 100,000 euros per person per bank (however there is not yet a pan-EU deposit guarantee scheme but national schemes).
  • Finally, the EBU would not be complete should we not pay attention to the role of the ECB and the National Central Banks as the lenders of last resort in the Euro area. Modern central banks (particularly since the 19th century, but also earlier in the case of the Bank of England) were established to support the banks in case of a liquidity crisis. If a bank is solvent but illiquid, and thus cannot pay its deposits temporarily, the bank can always request extraordinary lending to the central bank (as W. Bagehot put it in his famous 1873’s seminal book: unlimited lending but always against collateral and at a penalty rate). However, this competence is still in the hands of the National Central Banks in the Euro zone which, provided there is no objection of the ECB, can lend money to the national bank in crisis at request. This division of competences between the ECB and the National Central Bank should be better coordinated so no banking crisis is artificially ‘hidden’ or postponed under the provision of liquidity by the national central bank.

The ‘Euro 2.0’

As Jose Manuel Gonzalez Paramo put it, the European Banking Union is a sort of ‘Euro 2.0‘ as it comes to remedy (at least some) of the Euro 1.0 institutional problems and weaknesses. In this regard, I agree it is an improvement as it helps to create a more consistent and credible institutional setting (*); however it does not tackle important aspects I will just briefly mention below:

  • First of all, the EBU and the new Resolution Fund (paid for by the banks, its amount will be no less than 1% of banks’  guaranteed deposits) will not be completed until 2024. So, should a banking crisis occurs in the meantime the banking sector will not have enough funds to pay for the banks’ liabilities on its own or to fund and implement the decisions made by the SRM.
  • Secondly, if a bank needs to be assisted and finally resolved, a complicated coordination between many actors of divorced nature and aims (political, national and supranational) is required in a question of days/hours. Of course the test to this procedure will come when we experience the next banking crisis (see more details on chapter 2 by T. Huertas, see book mentioned above).
  • But finally and most importantly, in my opinion, the EBU does not resolve the fundamental problems of the Euro zone; which are the abysmal internal asymmetries amongst member states in terms of competitiveness, public finances or costs (see some measurements here), as well as the actual lack in internal and cross-border flexibility as regards labour and good and services markets. Just a view of the asymmetries in Target-2 member states’ balances is as striking as self-explanatory.

The EBU adds consistency and predictability to the supervision and resolution of banks. In this sense, it is an improvement. It also makes banks pay for the losses before applying any other funding, even less taxpayers money; but we are yet to see the robustness of the new institutions established as well as the political commitment to the bail-in option in reality. The EBU is in my view another ‘patch’ on the euro’s structural weaknesses.


Juan Castañeda


(*) However more consistent, I do not think this type of euro currency, very much centralised and linked to an increasingly powerful supranational State, is the best we could have established to preserve the purchasing power of the euro; I will elaborate further on the alternatives in next posts.

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El 2 de marzo de 12 a 14 horas en la Fundación Rafael del Pino (Madrid) tendré la oportunidad de participar en un coloquio con Jose Manuel González Páramo (BBVA, moderador), Pedro Schwartz (UCJC) y David Marsh (OMFIF) sobre cómo afectará Brexit a la Unión Bancaria Europea y a los servicios financieros que presta la llamada ‘City’ de Londres.

El tema, mejor dicho, los temas que hay sobre la mesa son verdaderamente complejos. Pero por supuesto que pueden tratarse de manera asequible para no especialistas; si hay algo que realmente me disgusta en Economía es cuando especialistas en la materia se enzarzan en un debate utilizando un lenguaje innecesariamente oscuro que no entiende nadie (algo que ocurre con demasiada frecuencia, casi de manera generalizada, con los artículos académicos en Economía …, lo que no les hace mejores sino más alejados de la realidad e incomprensibles). En concreto, seguro se tratará de cómo la salida del Reino Unido de la Unión Europea (UE) afectará a los servicios financieros que Londres, como plaza financiera de referencia en Europa, presta tanto a países como a empresas financieras y no financieras en el continente. Uno de las ideas que sostendré en el debate es que si Londres ha sido durante décadas (siglos) una plaza eficiente en la prestación de tales servicios, que por supuesto cumple con la regulación financiera Europea, por qué no debería seguir haciéndolo? Desde una perspectiva puramente económica, la cuestión no admite controversia: es eficiente y beneficioso para las dos partes aprovechar las ventajas competitivas que cada uno puede aportar en el comercio de bienes y servicios. Esto es algo que un estudiante de primero de Economía debería saber.

Hablaremos también de la union bancaria Europea, y de lo que implica e implicará en los próximos años en lo que se refiere a la regulación y, si fuera necesario, la liquidación ordenada de un banco en una futura crisis bancaria. Se trata de un conjunto de nuevas regulaciones e instituciones aprobadas por todos los países de la UE que tratan de paliar alguno de los fallos observados en las respuestas que los Estados Miembros dieron a las distintas crisis bancarias nacionales en la reciente crisis financieras. Y, aunque no muchos lo sepan, el Reino Unido, aún no siendo parte de la zona del Euro, como miembro de la UE sí ha tenido que cumplir con parte de la regulación que acompaña a la union bancaria Europea.

El evento también servirá para presentar el libro, ‘European Banking Union. Prospects and Challenges’ (Routledge), que hemos editado G. Wood D. Mayes y yo mismo. Se trata de una colección de capítulos que tratan de cómo se ha diseñado la union bancaria, su definición y funcionamiento, así como de algunos de los aspectos que en opinión de algunos de los autores puede poner en peligro su efectividad y viabilidad. Aquí podéis encontrar un resumen del libro, así como más información sobre los temas de los que trata:

‘Recent failures and rescues of large banks have resulted in colossal costs to society. In wake of such turmoil a new banking union must enable better supervision, pre-emptive coordinated action and taxpayer protection. While these aims are meritorious they will be difficult to achieve. This book explores the potential of a new banking union in Europe.

This book brings together leading experts to analyse the challenges of banking in the European Union. While not all contributors agree, the constructive criticism provided in this book will help ensure that a new banking union will mature into a stable yet vibrant financial system that encourages the growth of economic activity and the efficient allocation of resources.’

Quedáis invitados todos!

Juan Castañeda

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Two competing, free floating, currencies

My colleague and friend, Prof. Pedro Schwartz (President, Mont Pelerin Society), recently published a letter in the ‘Financial Times’ (‘Three conditions for a two-currency system’ praising the monetary system in Peru. Rather than a purely dollarised economy (either de facto or de iure), Peruvian authorities allow for the circulation of two currencies; the national currency (the ‘Sol’) and the US dollar. As Prof. Schwartz specifies in the letter, the system has been working rather well since its introduction in 1990, provided that three main conditions are met:

– Free movement of capital so Peruvians are free to put their income in either currency and take their money out of the country if they didn’t trust the national authorities.

– Both currencies freely float in the market, so their value clearly reflects the confidence of money holders on the issuer.

– And, in order to avoid the expel of the national currency from the market, the national central bank conducts an independent monetary policy focused on maintaining the purchasing power of the currency; which has resulted in a quite moderate rate of inflation in the last years. Doing so will foster the demand for the national currency on long term basis and thus make it attractive for the public.

Nothing really new so far; this type of two or even more currency systems worked well in the past all across the world: one currency was used for international trade, another for savings and possibly another for small transactions.  The government usually tried to control the parities but the price of the different currencies fluctuated in the market according to their purchasing power.

Those familiar with this blog won’t be surprised when I say that I do find this alternative monetary system a more desirable regime to both introduce more competition in the monetary system and thus discipline money issuers more effectively, as well as provide a convenient institutional tool for Euro zone member states in trouble to timely adjust their local costs and prices without the need to be expelled from the Euro (more details on this question here and here). Of course, this doesn’t mean that a devaluation of the local currency will solve all the problems, if not followed by credible and sound monetary and fiscal policies in the future under the three-condition system set out above.

Juan Castaneda

PS. I am currently working on a research paper with Prof. Schwartz to apply this system to the Euro zone (to be continued … soon).

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Very, very basic hints on how a fractional reserve and fully centralised monetary reserve monetary system works

It seems to be unnecessary but, given all it’s being said by all and sundry in the last two weeks, may I remind the kind readers of this blog that the current monetary crisis in Greece is just a textbook example of how a fully centralised monetary system works. I would have thought that the members of the recently appointed new government in Greece were well aware of the institutional and economic constraints of the euro, as well as the very much restricted range of manoeuvre a monetary union allows to its members. Let’s start with the very basics:

Under a fractional reserve and fully centralised monetary system such as ours, the ultimate source of liquidity is under the control of a central bank, the single issuer of the currency with legal tender power. The Greek economy (along with quite some other countries in the euro area) has been running persistent and quite significant current account deficits and, particularly since the outbreak of the 2007-08 financial crisis, has required the extraordinary assistance of the ECB. When no one was willing to lend out money to Greece, the ECB has not only taken part on the bail-out successive plan(s) granted to Greece but also, and most importantly, has been accepting Greek government bonds as collateral in its main refinancing operation with Greek commercial banks. The latter has been key to maintain a regular source of liquidity to the Greek economy and thus to avoid the collapse of its national monetary system and a run on Greek banks.

Along with the loans, the ECB (actually the so-called Troika with the other two institutional lenders, the EU Commission and the IMF) has imposed conditionality on the provision of the loans granted to Greece. And of course, this is the (natural) expected behaviour of any lender: those willing to lend out their money would like to be sure the borrower will be able to honour his debts. Needles to say that successive Greek governments have accepted the deal because no other international creditor was willing to make a loan to the country or to accept Greek bonds as collateral. Who else but your central bank could take such a high risk and keep on hoarding in its portfolio assets nobody wants? (By the way, all the shareholders of the ECB are contributing to these loans and supporting this continuous financial assistance in accordance to their percentage in the capital of the bank).

Now a new government in Greece is playing a quite risky game, with potentially disastrous consequences for the country. All along the campaign, Syriza has been denouncing the ‘imposition’ of the bail-out programmes and the loss of sovereignty of the Greek government in favour of the interests of the international creditors (let us leave aside the meaningless and populist rhetoric used by its dealers to refer to the bankers, capitalists and free marketeers as those wickedly pulling the strings in the shadow … ). They claim that the debt is unfair and needs to be restructured, if not partially or totally written off (may I remind one more time that a more than 50% ‘voluntary’ haircut was already accepted by private bondholders in 2012). Actually the new finance minister has been very busy in his recent road trip throughout   Europe to demand a change in the rules of the game; as if he was in a position to do so. Let me remind again few very basic facts in this regard:

– The more radical the demands of the Greek governments the more difficult it will become to find any other source of liquidity in international markets and thus the more dependent the Greeks will be on the single source of money available, the ECB. Actually the risk premium of Greek bonds has already exploded in the last two weeks and thus this situation has already materialised.

– The message that the Greek government couldn’t be willing to fulfil the conditions of the bail out programme has already increased capital flights out of the country and this shouldn’t be surprising at all (as it already happened back in 2012). And again, in this financially stressed scenario Greek banks are even more fragile and exposed to high liquidity constraints, which can only be sorted out by the assistance of the ECB (if willing to accept Greek bonds as collateral).

In this context we may well understand last week’s Mr Draghi’s reaction to the demands of the Greek government; in particular, his announcement that since next Wednesday Greek banks will no longer have access to the regular financing operations of the ECB via the ordinary discount of Greek bonds as collateral. This can only mean two things: either (hopefully) the precipitation of a new mutually beneficial deal between the new Greek government and the Troika or, if not feasible, the most likely sudden collapse of Greek banks as soon as the ECB stops providing liquidity to them on a regular basis. Well, perhaps another alternative might happen, which is the return to the national (devalued) currency (see an alternative in line with the introduction of more monetary competition in Europe here).

I do not know who advices the new Greek government on these matters but it would help to familiarise first with the very basics on money and central banking. All my best wishes to the Greeks of course!

Juan Castaneda

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An old (wrong) recipe: we all want to be consumers

I should start with an apology; it’s been far too long since my last post and I haven’t attended this blog as I would have liked. There have been so many things happening around in money and central banking that I will certainly need some time to catch up. I hope the patient readers of this blog find the forthcoming entries worthy of their time.

Last Autumn I was kindly invited to attend a very interesting seminar organised by the Institute of Economic Affairs (IEA) at its headquarters in London, and chaired by S. Davies; the topic was the so-called ‘stagnation hypothesis’, recently popularised by L. Summers at the 14th IMF Research Conference. Interesting as it was I am not going to write on it today but rather on a poem (that I must confess I hadn’t read at the time) a colleague of mine at the University of Buckingham (Malcolm Rees) brought to our attention. While we were in the midst of the discussion about the best way to tackle the slow (hypothetically secular) growth of the developed economies, Malcolm used his turn to read aloud a poem written in 1934 by Patrick Barrington, ‘I want to be a consumer’, which you will find below. Following the recipes of those economists supporting the underconsumption theory back in the 1930s, of course very well-known and popular well before the publication of Keynes’ General Theory, the poem summarises the views of a boy willing to consume more for the good of the economy as a whole. Then and now we all hear these young (and not so young) ‘lads’ encouraging us all to borrow more money and simply spend or even better asking the government to do so in our own interest, so the magical multiplier of spending operates the needed miracle. I am afraid this old recipe is quite short-sighted: as the brilliant (and austere) Catalan writer (Josep Pla) famously asked in 1954 during his visit to New York and saw all the lights displayed everywhere in the city, ‘and this, who pays for it?’. Even more, if adopted as a systematic policy, will this pattern of more and more spending be sustainable? And who works and saves more so we can increase production on long term basis? Well, I guess the answers to all these questions are only implicit in the poem and I am sure the readers of this blog will certainly know that these tricky questions are not so easy to answer; but indeed essential to bear in mind so perhaps we can avoid the same policy mistakes that have brought us to the chaotic economic situation where we are still in.

Juan E. Castaneda

PS. I am afraid ‘the old lady’ is back.

‘I Want to be a Consumer’

(by Patrick Barrington. Originally published in Punch, 25th April 1934. Text taken from the blog StudyofEconomics.wordpress.com)

“And what do you mean to be?”
The kind old Bishop said
As he took the boy on his ample knee
And patted his curly head.
“We should all of us choose a calling
To help Society’s plan;
Then what do you mean to be, my boy,
When you grow to be a man?”

“I want to be a Consumer,”
The bright-haired lad replied
As he gazed up into the Bishop’s face
In innocence open-eyed.
“I’ve never had aims of a selfish sort,
For that, as I know, is wrong.
I want to be a Consumer, Sir,
And help the world along.

“I want to be a Consumer
And work both night and day,
For that is the thing that’s needed most,
I’ve heard Economists say,
I won’t just be a Producer,
Like Bobby and James and John;
I want to be a Consumer, Sir,
And help the nation on.”

“But what do you want to be?”
The Bishop said again,
“For we all of us have to work,” said he,
“As must, I think, be plain.
Are you thinking of studying medicine
Or taking a Bar exam?”
“Why, no!” the bright-haired lad replied
As he helped himself to jam.

“I want to be a Consumer
And live in a useful way;
For that is the thing that’s needed most,
I’ve heard Economists say.
There are too many people working
And too many things are made.
I want to be a Consumer, Sir,
And help to further Trade.

“I want to be a Consumer
And do my duty well;
For that is the thing that’s needed most,
I’ve heard Economists tell.
I’ve made up my mind,” the lad was heard,
As he lit a cigar, to say;
“I want to be a Consumer, Sir,
And I want to begin today.”

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