European Macroeconomics Prof. Dr. Peter Bofinger
European Macroeconomics European Macroeconomics Prof. Dr. Peter Bofinger
Paul Krugman on Deficits and Keynes
Lecture 7 European Macroeconomics Prof. Dr. Peter Bofinger
Source: https://www.nytimes.com/2021/05/21/opinion/money-federal-reserve-deficit.html 3 European Macroeconomics Prof. Dr. Peter Bofinger „The Fed is basically acting as a financial intermediary“
Source: https://www.nytimes.com/2021/05/21/opinion/money-federal-reserve-deficit.html
4 European Macroeconomics Prof. Dr. Peter Bofinger High US government transfers generate high saving rate of private households
Transfers Household Saving Rate 6000,000 30,0
5000,000 25,0
4000,000 20,0
3000,000 15,0
2000,000 10,0
1000,000 5,0
0,000 0,0 1959-01-01 1960-06-01 1961-11-01 1963-04-01 1964-09-01 1966-02-01 1967-07-01 1968-12-01 1970-05-01 1971-10-01 1973-03-01 1974-08-01 1976-01-01 1977-06-01 1978-11-01 1980-04-01 1981-09-01 1983-02-01 1984-07-01 1985-12-01 1987-05-01 1988-10-01 1990-03-01 1991-08-01 1993-01-01 1994-06-01 1995-11-01 1997-04-01 1998-09-01 2000-02-01 2001-07-01 2002-12-01 2004-05-01 2005-10-01 2007-03-01 2008-08-01 2010-01-01 2011-06-01 2012-11-01 2014-04-01 2015-09-01 2017-02-01 2018-07-01 2019-12-01 Source: FRED 5 European Macroeconomics Prof. Dr. Peter Bofinger Krugman on „The economic consequences of cancelling Keynes“ (NYT 1 June 2021)
6 European Macroeconomics Prof. Dr. Peter Bofinger
V. The monetary policy of the ECB European Macroeconomics Prof. Dr. Peter Bofinger The „classical“ philosphy of the ECB: The financial sphere is a veil
The Monetary Policy of the ECSB (2011, p. 58)
“Since monetary policy can ultimately only influence the price level in the economy, price stability is the best contribution that a central bank can make to economic welfare and to the long-term growth prospects of the economy. Assigning monetary policy an objective for real income or employment would have been sub-optimal, since monetary policy has no scope for exerting any lasting influence on real variables in the short to medium term. (…) it is the task of other economic policy-makers, notably those responsible for fiscal and structural policies, to smooth real economic activity in the short term and to directly enhance the growth potential of the economy.”
8 1. The mandate of the ECB European Macroeconomics Prof. Dr. Peter Bofinger V(1). The mandate of the European Central Bank
1. Price stability as the objective of the ECB
2. The ECB’s definition of price stability // Why is price stability so important?
3. Is there a trade-off between price stability and the goal of high employment?
4. The assignment problem between fiscal policy and monetary policy
5. Is there a conflict of objectives between price stability and the objective of financial stability?
6. Can the ECB contribute to climate policy?
10 European Macroeconomics Prof. Dr. Peter Bofinger V(1). The mandate of the European Central Bank
1. Price stability as the objective of the ECB
2. The ECB’s definition of price stability // Why is price stability so important?
3. Is there a trade-off between price stability and the goal of high employment?
4. The assignment problem between fiscal policy and monetary policy
5. Is there a conflict of objectives between price stability and the objective of financial stability?
6. Can the ECB contribute to climate policy?
11 European Macroeconomics Prof. Dr. Peter Bofinger The one-dimensional mandate of the ECB: price stability
Article 127 of the Treaty on the Functioning of the European Union (TFEU):
§ "The primary objective of the European System of Central Banks (hereinafter referred to as the ESCB) shall be to maintain price stability.
§ Without prejudice to the objective of price stability, the ESCB shall support the general economic policies in the Union with a view to contributing to the achievement of the objectives of the Union as laid down in Article 3 of the Treaty on European Union." Image source: ECB
Source: https://eur- lex.europa.eu/LexUriServ/LexUriServ.do?uri=CELEX:12012E/TXT:de:PDF
12 European Macroeconomics Prof. Dr. Peter Bofinger The Objectives in Article 3, paragraph 3 of the EU Treaty
"The Union shall establish an internal market. It shall work for the sustainable development of Europe based on § balanced economic growth and § price stability, § a highly competitive social market economy, aiming at full employment and social progress, and § a high level of protection and improvement of the quality of the environment. It promotes scientific and technical progress."
13 European Macroeconomics Prof. Dr. Peter Bofinger The mandate of the Federal Reserve: price stability, high employment, moderate long-term interest rates
Defined in Section 2A of the Federal Reserve Act:
"The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long-run growth of the monetary and credit aggregates commensurate with the economy's long-run potential to increase production, so as to promote effectively the goals of maximum
employment, stable prices, and moderate Image source: Federal Reserve long-term interest rates."
Source: https://www.federalreserve.gov/aboutthefed/section2a.htm
14 European Macroeconomics Prof. Dr. Peter Bofinger V(1). The mandate of the European Central Bank
1. Price stability as the objective of the ECB
2. The ECB’s definition of price stability // Why is price stability so important?
3. Is there a trade-off between price stability and the goal of high employment?
4. The assignment problem between fiscal policy and monetary policy
5. Is there a conflict of objectives between price stability and the objective of financial stability?
6. Can the ECB contribute to climate policy?
15 European Macroeconomics Prof. Dr. Peter Bofinger The ECB's definition of price stability:
§ Price index: Harmonised index of consumer prices (HICP) collected in a uniform way in all Member States § Target for the euro area as a whole, i.e. developments in individual countries are not relevant for the ECB § Time horizon: "medium term" § Target: Inflation rate "of below but close to 2%". § Symmetry: "The key point is that the Governing Council is symmetric in the definition of the objective of price stability over the medium term". (Mario Draghi at a press conference on 10 March 2016, source: https://www.ecb.europa.eu/press/pressconf/2016/html/is160310.en.html)
16 European Macroeconomics Prof. Dr. Peter Bofinger Why "below but close to 2%" and not an inflation target of 0%?
§ More room for maneuvre in the event of negative shocks: § With 2% target inflation and a neutral real interest rate of 2%, the nominal interest rate in equilibrium would be 4%. § With 0% target inflation, the nominal interest rate in equilibrium would be only 2%. § In case of a negative shock, due to the zero lower bound (ZLB) for nominal interest rates, central banks can cut interest rates by 4 percentage points with a 2 % target, and only by 2 percentage points with 0 % target. § In a monetary union with autonomous member states, some countries would have to accept deflation with an average inflation target of 0%. → But this also speaks against a higher target (for example 4 %), because then a some number of countries would have to accept quite high inflation.
17 European Macroeconomics Prof. Dr. Peter Bofinger Target inflation rates of central banks in advanced economies are mostly 2%
AUSTRALIA Reserve Bank of Australia 2.00% - 3.00% NEW ZEALAND Reserve Bank of New Zealand 2.00% +/-1.0%
BRAZIL Central Bank of Brazil 4.25% +/-1.5% NORWAY Norges Bank 2.00%
CANADA Bank of Canada 2.0% +/-1.0% PAKISTAN State Bank of Pakistan 6.00%
CHILE Central Bank of Chile 3.00% +/-1.0% POLAND National Bank of Poland 2.5% +/-1.0%
CHINA People's Bank of China around 3.00% SOUTH KOREA Bank of Korea 2.00%
CZECH REPUBLIC Czech National Bank 2.00% +/-1.0% SWEDEN The Riksbank 2.00%
HUNGARY Central Bank of Hungary 3.0% +/-1.0% SWITZERLAND Swiss National Bank <2.00%
ISRAEL Bank of Israel 1.00% - 3.00% UNITED KINGDOM Bank of England 2.00%
JAPAN Bank of Japan 2.00% Source: http://www.centralbanknews.info/p/inflation-targets.html 18 European Macroeconomics Prof. Dr. Peter Bofinger The ECB has been able to achieve its inflation target relatively well
Inflation in the euro area 5
4
3
2
1
0
-1 Jul. 01 Jul. 06 Jul. 11 Jul. 16 Apr. 00 Okt. 02 Apr. 05 Okt. 07 Apr. 10 Okt. 12 Apr. 15 Okt. 17 Apr. 20 Jan. 99 Jun. 99 02Mai. Jan. 04 Jun. 04 07Mai. Jan. 09 Jun. 09 12Mai. Jan. 14 Jun. 14 17Mai. Jan. 19 Jun. 19 Feb. 01 03 Mär. Feb. 06 08 Mär. Feb. 11 13 Mär. Feb. 16 18 Mär. Feb. 21 Nov. 99 Nov. Sep. 00 01 Dez. Aug. 03 04 Nov. Sep. 05 06 Dez. Aug. 08 09 Nov. Sep. 10 11 Dez. Aug. 13 14 Nov. Sep. 15 16 Dez. Aug. 18 19 Nov. Sep. 20 Core inflation (excluding energy and unprocessed food) HICP Inflation target
Source: ECB, SDW 19 European Macroeconomics Prof. Dr. Peter Bofinger In Germany, inflation in the euro phase (1999-2019) was only half as high as in the D-Mark phase (1949-1998)
Inflation rate in Germany (1950-2019) Inflation rate Average inflation rate 1949-1998: 2.8%. Average inflation rate 1998-2019: 1.4% 10
8
6
4
2
0
-21950 1952 1954 1956 1958 1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018
-4
-6
-8
Source: Bundesbank
20 European Macroeconomics Prof. Dr. Peter Bofinger Why does price stability matter? Money plays a central role in the market economy
§ The market economy is based on the division of labour and the exchange of goods via markets. Prices are signalling and coordination mechanism of this system. This requires low inflation rates. § The functions of money § As a unit of account, it enables the comparison of prices of goods and services ("numéraire") § As a means of payment, it facilitates exchange at markets. § As a store of value, it allows for easy intertemporal storage of assets.
21 European Macroeconomics Prof. Dr. Peter Bofinger Money as a store of value
DAX and gold price § Many investors have a preference for safe DAX (1987=100), left scale Gold price (US dollars per troy ounce), right scale and liquid investments ("safe assets"). 14000 2.000 Shares, gold or real estate show strong 1.800 12000 fluctuations in value. Real estate is a less 1.600 liquid asset and represents a cluster risk. 10000 1.400 1.200 8000 § Bank deposits (money in the sense of M1 or 1.000 6000 M2) are a very liquid and, with low inflation, 800
quite stable store of value DAX (1987=1000) 4000 600 400 US DOLLAR PER OUNCE 2000 § High inflation leads to a "flight into real 200 assets" (gold, real estate), which is often 0 0
associated with misallocations Jul 97 Okt 91Okt Apr03 14Okt Mai Mai 01 Jun Jun 99 Jan 09 Mär 05Mär Feb 07 Dez Dez 87 Nov 89 Sep 93 Aug 95 Dez 10 Nov 12 Sep 16 Aug 18
Source: Bundesbank
22 European Macroeconomics Prof. Dr. Peter Bofinger V(1). The mandate of the European Central Bank
1. Price stability as the objective of the ECB
2. The ECB’s definition of price stability // Why is price stability so important?
3. Is there a trade-off between price stability and the goal of high employment?
4. The assignment problem between fiscal policy and monetary policy
5. Is there a conflict of objectives between price stability and the objective of financial stability?
6. Can the ECB contribute to climate policy?
23 European Macroeconomics Prof. Dr. Peter Bofinger The experience of the 1980s: stagflation Countries with high inflation tend to have higher unemployment
Inflation and Unemployment in 1982 Inflation and Unemployment in 1982 Unemployment rate Inflation rate 18 25 16
14 20 12 15 10
10 8
Inflation rate 6 5 4
0 2
Italy USA Japan Spain 0 AustriaSweden GreeceFinland France CanadaBelgium GermanyAustraliaPortugalDenmark 0 5 10 15 20 25 Switzerland Netherlands New Zealand Unemployment rate United Kingdom
Source: IMF, WEO Database, April 2020
24 European Macroeconomics Prof. Dr. Peter Bofinger The short-term perspective: Demand and supply shock in the IS/MP/PC-model
Demand shock: No trade-off between inflation Supply shock: Trade off between inflation and output stabilisation and output stabilization
25 European Macroeconomics Prof. Dr. Peter Bofinger Trade-off between price stability and output (=employment stabilisation) is determined by the nature of the shock
§ In the case of demand shocks, e.g. COVID pandemic: By preventing deflation, the central bank simultaneously stabilises national income and prevents unemployment. Thus, there is no trade-off § In the case of supply shocks, e.g. higher energy prices: The central bank faces a trade-off - If it stabilises the inflation rate, it generates additional losses in national income - If it stabilises national income, the inflation rate moves further away from its target value
26 European Macroeconomics Prof. Dr. Peter Bofinger The trade-off in the event of supply shocks can be mitigated by the medium-term orientation of the ECB
Oil price and inflation in the euro area Brent oil price per barrel in USD (left scale) Harmonised Index of Consumer Prices euro area (right scale) 140,00 5,0
120,00 4,0
100,00 3,0
80,00 2,0 60,00
1,0 USD PER BARREL 40,00 INFLATION RATE (IN%) RATE INFLATION
0,0 20,00
0,00 -1,0 Jul. 99Jul. 00Jul. 01Jul. 02Jul. 03Jul. 04Jul. 05Jul. 06Jul. 07Jul. 08Jul. 09Jul. 10Jul. 11Jul. 12Jul. 13Jul. 14Jul. 15Jul. 16Jul. 17Jul. 18Jul. 19Jul. Jan. 99Jan. 00Jan. 01Jan. 02Jan. 03Jan. 04Jan. 05Jan. 06Jan. 07Jan. 08Jan. 09Jan. 10Jan. 11Jan. 12Jan. 13Jan. 14Jan. 15Jan. 16Jan. 17Jan. 18Jan. 19Jan. 20Jan. Source: ECB, SDW 27 European Macroeconomics Prof. Dr. Peter Bofinger Supply shocks become a problem when the lead to „second- round-effects“
p
P�(� = � ) Second-round effects: P�(� = � ) → Inflation rate expectations are no longer determined by the central bank p2 but by higher inflation rate targets L p1 p 0 L
0 y
28 European Macroeconomics Prof. Dr. Peter Bofinger V(1). The mandate of the European Central Bank
1. Price stability as the objective of the ECB
2. The ECB’s definition of price stability // Why is price stability so important?
3. Is there a trade-off between price stability and the goal of high employment?
4. The assignment problem between fiscal policy and monetary policy
5. Is there a conflict of objectives between price stability and the objective of financial stability?
6. Can the ECB contribute to climate policy?
29 European Macroeconomics Prof. Dr. Peter Bofinger In the Keynesian model monetary and fiscal policy and monetary policy have effects on output and inflation
r
r § In the IS/MP/PC model, fiscal policy 0 MP0 can be be represented as an +� additional term in the IS curve (f). It IS1 IS0 reflects government expenditures as a y determinant of aggregate income. �
� = � − �� + � + �
§ With its expenditures, the government ∗ can shift the IS-curve which has an � impact on the inflation rate ∗ �0 < �
y y0<0 0
30 European Macroeconomics Prof. Dr. Peter Bofinger Responsibility of governments for price stability
Abba Lerner: Functional Finance and the Article 1 of the Act to Promote Economic Federal Debt (1943) Stability and Growth in Germany (1967): “The first financial responsibility of the “In their economic and fiscal policy government (since nobody else can measures, the Federation and the states undertake that responsibility) is to keep the shall observe the requirements of overall total rate of spending in the country on economic equilibrium. These measures goods and services neither greater nor less shall be taken in such a way that, within the than that rate which at the current prices framework of the market economy, they would buy all the goods that it is possible simultaneously contribute to price stability, to produce. If total spending is allowed to to a high level of employment and go above this there will be inflation, and if it external equilibrium, accompanied by is allowed to go below this there will be steady and adequate economic growth” unemployment.”
31 European Macroeconomics Prof. Dr. Peter Bofinger The role for fiscal policy in a deflationary environment
Euro area: interest rates and inflation
1-month euro interest rate (left scale) Zero lower bound (left scale) Euro area: real government expenditures 2 year ahead inflation forecast (right scale) ECB inflation target (right scale) (Percent change from one year ago)
6,0 2,5 Euro area Germany
5,00 5,0 2 4,00 4,0 3,00 1,5 3,0 2,00
2,0 1,00
1 INFLATION TERM INTEREST RATE - 0,00 1,0
0,5 -1,00 SHORT 0,0
-2,00 -1,0 0 -3,00
1999 Q1 1999 Q4 1999 Q3 2000 Q2 2001 Q1 2002 Q4 2002 Q3 2003 Q2 2004 Q1 2005 Q4 2005 Q3 2006 Q2 2007 Q1 2008 Q4 2008 Q3 2009 Q2 2010 Q1 2011 Q4 2011 Q3 2012 Q2 2013 Q1 2014 Q4 2014 Q3 2015 Q2 2016 Q1 2017 Q4 2017 Q3 2018 Q2 2019 Q1 2020 Q4 2020 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
32 European Macroeconomics Prof. Dr. Peter Bofinger The role for monetary policy in a monetary union
Inflation divergences in 2000-2007 § If a country is confronted with a Germany Greece Spain ECB Target 4,5 idiosyncratic demand shock, the ECB can only partially compensate 4 the shock 3,5 3 § The ECB reaction has negative effects for the other member states 2,5 2 § Therefore, national fiscal policy is the 1,5 required instrument for stabilizing the inflation rate and unemployment at the 1 national level 0,5 0 2000 2001 2002 2003 2004 2005 2006 2007
33 European Macroeconomics Prof. Dr. Peter Bofinger V(1). The mandate of the European Central Bank
1. Price stability as the objective of the ECB
2. The ECB’s definition of price stability // Why is price stability so important?
3. Is there a trade-off between price stability and the goal of high employment?
4. The assignment problem between fiscal policy and monetary policy
5. Is there a conflict of objectives between price stability and the objective of financial stability?
6. Can the ECB contribute to climate policy?
34 European Macroeconomics Prof. Dr. Peter Bofinger In the phase up to 2008, the ECB was one-sidedly fixated on price stability and overlooked risks in the financial system
Statement by the then ECB President Trichet on 12 July 2007 (i.e. about 2 weeks before the start of the financial crisis): Claude_Trichet1.jpg - “Given the vigorous monetary and credit growth in an environment of already ample liquidity, a cross- check of the outcome of the economic analysis with that of the monetary analysis supports the assessment that upside risks to price stability prevail over the medium to longer term." https://commons.wikimedia.org/wiki/File:Jean Source: Source: Source: Introductory statement with Q&A by Jean-Claude Trichet, 5 July 2007
35 European Macroeconomics Prof. Dr. Peter Bofinger Credit and money supply developments in the euro area
Growth rate of the money supply M3 and Bank loans to the private sector in bank loans at euro area (vis-à-vis selected countries (Jan. 1999=100) previous year) Euro area Ireland Spain Greece Germany M3 Loans in the euro area 600 14 12 500 10 400 8 6 300 4
2 200 0 -2 100 -4 0 1.1.1999 9.1.2002 8.1.2003 7.1.2004 6.1.2005 5.1.2006 4.1.2007 3.1.2008 2.1.2009 1.1.2010 9.1.2013 8.1.2014 7.1.2015 6.1.2016 5.1.2017 4.1.2018 3.1.2019 2.1.2020 Jul. 99Jul. 00Jul. 01Jul. 02Jul. 03Jul. 04Jul. 05Jul. 06Jul. 07Jul. 08Jul. 09Jul. 12.1.1999 11.1.2000 10.1.2001 12.1.2010 11.1.2011 10.1.2012 99Jan. 00Jan. 01Jan. 02Jan. 03Jan. 04Jan. 05Jan. 06Jan. 07Jan. 08Jan. 09Jan.
Source: ECB, SDW 36 European Macroeconomics Prof. Dr. Peter Bofinger Trade-off
§ If the ECB had raised interest rates in the years up to 2007 in order to curb credit growth, the economy would have slowed down and inflation would have been too weak § The trade-off can be reduced by macroprudential policy. These are measures that specifically slow down credit expansion, e.g. -Upper limits for the mortgaging of real estate (Loan to value ratios) -Upper limits for the burden of interest and redemption payments in relation to a borrower's income (Loan to income ratios) -Additional capital requirements for bank lending (Leverage ratio)
37 European Macroeconomics Prof. Dr. Peter Bofinger V(1). The mandate of the European Central Bank
1. Price stability as the objective of the ECB
2. The ECB’s definition of price stability // Why is price stability so important?
3. Is there a trade-off between price stability and the goal of high employment?
4. The assignment problem between fiscal policy and monetary policy
5. Is there a conflict of objectives between price stability and the objective of financial stability?
6. Can the ECB contribute to climate policy?
38 European Macroeconomics Prof. Dr. Peter Bofinger New ECB President announces new ECB strategy
"Indeed it (the new strategy; PB) will also address the major changes that have taken place over the course of the last 16 years, and by that I include the massive technological change that our societies are facing. It will include the immense challenge that climate change is addressing to each and every one of us, wherever located, and whatever our mission and duties." - Press conference 12 December 2019 Source: https://commons.wikimedia.org/wiki/File:Christine_Lagarde_(cropped).jpg Source:
39 European Macroeconomics Prof. Dr. Peter Bofinger The ECB contribution to climate policies
"The Union shall establish an internal market. It shall work for the sustainable development of Europe based on balanced economic growth and price stability, a highly competitive social market economy, aiming at full employment and social progress, and a high level of protection and improvement of the quality of the environment. It promotes scientific and technical progress."
Source: Treaty on European Union - Article 3
40 European Macroeconomics Prof. Dr. Peter Bofinger Article 3, paragraph 3 of the EU Treaty: Environment as an important objective
§ The main responsibility for climate policies lies with the national governments and the European Union - Carbon taxes - Support for renewable energies - Debt financing via capital markets § In the case of financing constrains on capital markets, the ECB could purchase such bonds § The specific contribution of the ECB: preferential treatment of green bonds in its corporate bond purchases § Isabel Schnabel: „One possible avenue for action is to incorporate sustainability criteria into the implementation of our private sector asset purchases. In light of the observed emission bias in our corporate bond portfolio, we need to carefully re-assess the
current notion of market neutrality.” Source: https://www.ecb.europa.eu/press/key/date/2021/html/ecb.sp210303_1~f3df48854e.en.html
41 European Macroeconomics Prof. Dr. Peter Bofinger
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