Bill Mitchell-en ECB realises it has to keep funding Member State deficits for the foreseeable future
(http://bilbo.economicoutlook.net/blog/?p=47563)
(i) Sarrera gisa
(…) I have been examining European data and matching them against a recent interview (May 26, 2021) – Interview with Fabio Panetta, Member of the Executive Board of the ECB, conducted by Jun Ishikawa – that Nikkei published yesterday. Things have changed a bit in Europe since the GFC although the fundamental problem of the Eurozone remains – there is a disjuncture between fiscal responsibility and fiscal capacity and the only way that that mismatch is being addressed is the via the on-going ECB funding of fiscal deficits, despite the denial that that is what is happening. It is plainly obvious to all.
(ii) Europako aurrezki ratioak
Saving ratios in Europe are high and rising
The first thing to appreciate is that household saving ratios (as a proportion of disposable income) are very high and have been rising sharply since the pandemic.
That is, with one exception.
The first graph shows the household saving ratios for the EU27 and the 19 Member States of the Eurozone since 1999. The Eurostat data goes up to the December-quarter 2020.
By Australian standards these are the sort of ratios we saw in the 1960s before the neoliberal credit frenzy pushed them into negative territory.
It is also important to note that the rising fiscal deficits have helped ‘fund’ the rising saving ratios although the fact that overall growth is still negative means that the deficits have not been large enough to satisfy the desire for rising saving and offset the declining household consumption expenditure.
The point is that with high household saving ratios diverting income generation away from expenditure, other sources of expenditure are necessary to ensure employment growth is strong.
The next graph shows the same data for selected Eurozone nations – compared to the currency union average.
German households are now saving around 25 per cent of their disposable income and French households around 20 per cent.
Think about what else is going on in each of these nations.
Germany is running a huge external surplus, while France is running a large external deficit.
Germany runs an investment ratio of around 20 per cent of GDP, while France is higher at around 25 per cent.
So for Germany, the two sectors that make up the non-government sector overall are in surplus, while in France they are in deficit.
The implications for the fiscal positions are different with France likely to require higher deficits to sustain growth given the leakage via the external sector.
And the last graph contrasts the situation in German (high household saving and personal risk management) to that of Greece which has seen austerity severely squeeze household income and forced people to dis-save to maintain a semblance of life.
The consequences of that will devastate that nation for years to come.
Those graphs are background to my response to the Panetta Interview with Nikkei.
(iii) EBZ-ko kontseilu kideko Fabio Panetta-rekiko elkarrizketa
Interview with ECB Board Member, Fabio Panetta
Panetta summarised the economic situation in the Eurozone:
1. “recovery is incomplete: euro area GDP is still 5.5% below its pre-pandemic level and even further beneath its pre-crisis growth trend.”
2. “This means that millions of jobs lost during the pandemic have not been recovered.”
3. “job retention schemes continue to play a major role: in the euro area, the share of workers who are unemployed, discouraged or enrolled in such schemes is around 17%, double the headline unemployment rate.”
4. “the economy still relies on the oxygen provided by both monetary and fiscal policy: we are far from the point where we can see self-sustained growth.”
The obvious point is that the “oxygen” has been in short or restricted supply – revert to point 1.
Why are nations outside the Eurozone (like the UK and Australia) experiencing positive growth while the Eurozone is still wallowing in recession?
The Eurozone is being choked by a lack of “oxygen”.
Why?
Because fiscal policy is in the hands of the Member States who do not have the currency capacity to expand sufficiently.
Yes, the Stability and Growth Pact rules have been suspended temporarily, the culture that the rules have created have created a lack of adventure among political leaders who fear, rightly, that Brussels will force them into harsh austerity at some point in the future.
Further, the Next GenerationEU funds have not been deployed yet after 18 months or so of (typical) disagreement among the Member States.
These disagreements make it virtually impossible for the EU to meet emergencies such as the pandemic in any functional way.
A given crisis will always be worse in the EU than elsewhere.
The relevant point to this blog post is that the ECB, which is the currency issuer in the EMU, is ensuring that any deficits that are being incurred by Member States are being funded via their bond buying program, without forcing the Member States to be at the behest of private bond markets.
The question that has been raised continually over the last year or so as the scale of the asset purchase programs has been ramped up is when the ECB will reduce their purchases.
That was a question that Fabio Panetta was keen to address and put paid to the rising calls from conservatives for the ECB to start retrenching its support to the Member States.
He said:
In such an environment, a premature withdrawal of policy support would risk suffocating the recovery before it becomes self-sustained. And it would exacerbate uncertainty, further weighing on demand.
We didn’t hear that during the GFC when despite the ECB conducting asset buying programs the conditionality for such purchases was that the Member States had to implement austerity, years before fiscal withdrawal was indicated by the circumstances.
Fabio Panetta also shifted the focus from financial variables to real variables, which is appropriate:
… we must continue to closely monitor the incoming data and ensure that the exit from the crisis is supported by a robust and lasting recovery. The output gap, the employment gap and the inflation gap are the key variables to determine when we have truly gone beyond the pandemic phase.
The shift in rhetoric is clear.
The talk is not about fiscal rule thresholds being breached but about employment and output.
I did some calculations.
Total Member State (consolidated) public debt rose by 1,080,285 million euros over the course of 2020.
The ECB’s holdings of government debt rose by 1,055,452 million euros, which is 97.7 per cent of the debt issued (in net terms) over 2020.
In the first 20 weeks of 2021, ECB holdings of government debt have risen a further 406,523 million euros.
We don’t yet know by how much government debt has risen in the first 20 weeks of 2021.
The point is that ECB has essentially purchased all the debt issued since the beginning of the pandemic and then some (probably).
That is far more than is necessary to satisfy “securities held for monetary policy purposes”, which is how they classify their purchases.
They are funding government deficits and everyone knows it.
Fabia Panetta was then asked (inevitably and boringly) to respond to the statement that “It looks like inflation is coming back, doesn’t it?”.
He said:
… this will be a temporary hump: it is not expected to last beyond this year, as it’s not self-sustained and it’s not domestically driven. In any case, underlying inflation, which is mainly driven by domestic services, remains very low, at 0.7% in April.
We are getting increased hysteria about small price changes from a very low base.
But again, note the link to the real economy “not domestically driven” rather than just equating the large-scale QE program with an expanding money supply and – inflation.
In fact, he considered the risk wa that “inflation is going to remain well below our objective of 2%” and that this ” may affect our credibility after so many years of inflation ‘misses’.”
What it demonstrates is that the central bank cannot just arbitrarily push up the inflation rate by adding reserves to the banking system, which is a major repudiation of mainstream macroeconomic theory.
Of course, in the interview he denied that and said instead that “the level of inflation in the medium term is still decided by the central bank” and the interviewer didn’t push him to explain how!
The interview then shifted to the Pandemic Emergency Purchase Program (PEPP), which is just an additional government bond buying program added to the existing programs.
All the interest has been on whether the ECB would continue this program after June 2021.
The answer is clear from Fabio Panetta:
… only a sustained increase in inflationary pressures, reflected in an upward trend in underlying inflation and bringing inflation and inflation expectations in line with our aim, could justify a reduction in our purchases.
So while the ECB might abandon the PEPP, the additional purchases will just be tacked onto the existing APP if his view prevails at the board level.
He went further and noted that:
… we are now seeing a further undesirable increase in yields …
Which reinforces the ECB’s motivation to keep controlling yields at low levels by ramping up the bond-buying program.
The interview then diverted into discussions of digital currency, which I will not comment on.
Ondorioak
(1) The point is that the ECB knows well that it is the only thing holding the monetary union together.
(2) Without this massive funding of Member State deficits (which are too low to be sure), many Member States would become insolvent fairly quickly – Italy would be first in the queue.
(3) And with the high household saving ratios across the zone bar the destroyed Greece, there is a lot of expenditure leakage that has to be filled by government net spending.
(4) The Europeans have got themselves into a real bind as a result of the dysfunctional monetary architecture they pushed onto their citizens.
(5) The system is austerity biased and the democratically deficient.
(6) And for its continuity, it relies on the central bank essentially acting outside the legal framework established in the treaties, although it denies that.
(7) And that continuity cannot deliver a desirable standard of living for its citizens in general.
joseba says:
EBZ ia garbi: defizit handiagoak, QE handiagoa
Bill Mitchell-en ECB nearly comes clean – higher fiscal deficits, higher QE
(http://bilbo.economicoutlook.net/blog/?p=48167)
Last year, the US Federal Reserve dropped a bombshell on mainstream macroeconomics by abandoning the consensus approach to monetary policy, which prioritised fighting inflation over maintaining low levels of unemployment, and, increasing interest rates well before any defined inflationary pressures were realised – the so-called forward guidance approach. It has also been buying massive quantities of US government debt and controlling bond yields in the markets as a result. Attention has been on the ECB to see where it would pivot too and whether it was going to abandon its own massive government bond buying program any time soon, which has been effectively funding the fiscal deficits of the 19 Member-States of the Eurozone. Recent statements have indicated the QE programs in Europe will not be ending any time soon. And an ECB Board member all but tied the scale of the purchasing programs to the size of the fiscal deficits as a guide to how long and how large the QE interventions would be.
On March 20, 2020, the ECB added the Pandemic Emergency Purchase Programme (PEPP) to it already, rather large, public asset purchasing program.
The press release – ECB announces €750 billion Pandemic Emergency Purchase Programme (PEPP) – said that PEPP was:
… new temporary asset purchase programme of private and public sector securities to counter the serious risks to the monetary policy transmission mechanism and the outlook for the euro area posed by the outbreak and escalating diffusion of the coronavirus, COVID-19.
The main (apparently, non-temporary) Asset Purchasing Program (APP), whcih includes the corporate sector purchase programme (CSPP), the public sector purchase programme (PSPP), the asset-backed securities purchase programme (ABSPP), and the third covered bond purchase programme (CBPP3), but, which, is dominated by the PSPP.
By the end of July 2021, the ECB has accumulated 3,038,684 million euros of assets, 2,429,274 million euros in the PSPP and is purchasing around 20 million euros worth a month.
So a very significant funding of Member State deficits through this program, which really began in May 2010 when the ECB introduced the Securities Markets Program to save several Member States from insolvency.
On top of that we have the PEPP which by the end of July 2021 has accumulated 1,263,348 million euros worth of assets, including 1,220,424 million worth of government bonds.
The ECB is in net terms buying around 80 million euros of government debt each month, although the figure fluctuates during to redemptions etc.
And despite all the inflation hawks claiming that the ECB will have to dramatically scale back its programs, the latest data shows the ECB has actually started to ramp up its government bond purchases in recent months.
Here is the history of the PEPP which began in March 2020.
The data shows that, far from worrying about all the inflation mania, the ECB is steaming full speed ahead funding the 19 Member State deficits and keeping them solvent.
The objective – to ensure the eurozone doesn’t break up.
Reality: breaking the Treaty but then without this massive bond-buying program the common currency would be dead.
…
There were some interesting statements coming out of the ECB in the last week.
The first, was an interview with Focus that the ECB Executive Board member Isabel Schnabel gave on August 17, 2021 (published August 20, 2021).
Referring to the disastrous fires in Greece, she was asked why “climate change … is a topic for a central bank”.
The question may have been better framed as ‘why is it a topic for a central bank in a financial system where the government treasuries (fiscal authorities) have no currency sovereignty?’
The ECB is not just any central bank.
It is both the currency issuer and the major source of fiscal support as evidenced by the on-going APP and PEPP.
Isabel Schnabel answered that:
Climate change has far-reaching effects on economic developments and therefore also on price stability – which is our main task. For example, it exposes the economy to more frequent macroeconomic shocks, which has an impact on growth and inflation.
Notice the slippage between “price stability” in sentence one to “growth and inflation” in sentence two.
The interviewer continued to prod – isn’t it “up to governments to respond to that” to which she responded:
Of course governments are primarily responsible for taking action. But we as the central bank cannot just stand on the sidelines and do nothing … climate change has large implications for price stability …
She admitted that climate change may have both inflationary and deflationary effects.
She also admitted that the ECB continued to buy bonds from carbon-intensive firms because “we have up to now been guided by the bonds available in the market”.
The interchange that followed was torturous because apparently the worst climate offenders have the largest adjustments to make so they need to be ‘funded’ through the APP and PEPP but that just meant they kept polluting for longer.
Crazy.
Why not just send them broke through regulation?
And the availability argument is crucial.
The ECB cannot just target ‘green bonds’ because “there would still be far too few green bonds” available.
On inflation and the direction of the APP and PEPP, she said she wasn’t worried about inflation and that:
… in the medium term … we expect inflation in the euro area to be below our target of two per cent. As surprising as it may sound to some – we are more worried about the inflation rate being too low in the medium term rather than too high.
Most relevant to today’s message though was her next answer relating to the way the ECB has changed its concept of the inflation target.
The question and answer was:
Q: Why exactly did the ECB change its inflation target? It used to be “below, but close to, two per cent”, now the inflation rate is also allowed to moderately exceed it.
A: The old wording was less clear and had occasionally been misinterpreted. Some had seen it as a ceiling, assuming that while inflation must not exceed it, undershooting it would not be a problem. That is why we made it clear: the target for us is two per cent. And it is symmetric, meaning that too low inflation is considered equally undesirable as too high inflation.
Further elaboration of forward guidance
On August 19, 2021, the ECB Board member Philip Lane published a blog post – The new monetary policy strategy: implications for rate forward guidance – which further elaborated on what Isabel Schnabel was referring to and sought to align the ECB policy approach with global trends, started by the US Federal Reserve last year.
Philip Lane sought to explain the ECBs:
… new monetary policy strategy, since it is essential that our approach to setting our policy rates is fully aligned with delivering our symmetric two per cent inflation target over the medium term.
Note the term “symmetric” – they are now consolidating that deviations below the target are as worrying as deviations above it.
The important observation was that during a deinflationary episode the ECB had limited scope “to lower rates into negative territory, owing to the lower bound on cash”.
The problem is that if the ECB pursues negative rates for too long as the economy is hit by a sequence of deflationary shocks, then:
… this could result in inflation expectations settling below the central bank’s target inflation rate.
They still believe that inflationary expectations drive the inflation dynamic and can be manipulated through monetary policy adjustments.
The evidence for that statement is weak but it remains the dominant view among central bankers.
When you go to a surgeon expect to be told that surgery is required.
The same for a central banker – they are hardly going to deny their existence and admit that monetary policy is largely ineffective.
The upshot of his view is that in times like this where the ‘lower bound’ is the problem, the right policy “requires especially forceful or persistent monetary policy action”, which is then used to justify “monetary accomodation on a persistent basis” – decoded, on-going APP and PEPP or whatever else they determine will be the name of the asset-purchasing programs.
The second upshot is that their monetary policy approach – “symmetric two per cent inflation target” – will only adjust interest rates upwards if “it sees inflation reaching two per cent well ahead of the end of its projection horizon and durably for the rest of the projection horizon”.
This means that spikes in inflation, if deemed to be transitory, will not trigger interest rate shifts, unlike the past, where the ECB was trigger happy and freaked out at the meagre suggestion of inflation.
So this is in line with the message that the US Federal Reserve pumped out last year, even if the wording from the ECB is more tempered and doesn’t outrightly say the ECB will prioritise reducing unemployment and tolerate periods of higher inflation as long as the average inflation rate is within their target.
In fact, Philip Lane never mentions employment or unemployment.
Then a Reuters’ interview takes us further
Which takes us to the interview published by Reuters (August 25, 2021) – Interview with Philip R. Lane, Member of the Executive Board of the ECB, conducted by Balazs Koranyi and Frank Siebelt – which really allows us to see the close connection between fiscal and monetary policy ECB-style.
He was asked whether it was “still appropriate to maintain “significantly higher” PEPP purchases, and his, rather elongated answer, just kept talking about maintaining “favourable financing conditions”, which is ECB-speak for ensuring yields remain low and governments don’t become insolvent.
They would never admit that but that is the reality.
Without the PEPP (and the PSPP) crisis-ridden Member States would quickly encounter private bond market conditions that would be unviable and they would have to default.
He also admitted that the PEPP will be reviewed in March 2022, but, even if the PEPP is closed:
Asset purchases will continue after PEPP because we’ll have our regular asset purchase programme (APP) running, as conditions to end APP are not there.
Those conditions are that the ECB understands fully that the death-spiral would quickly return to some Member States, in terms of their solvency status, if the ‘market’ realised that the ECB was no longer going to buy most of the debt issued in the secondary markets via their various asset-purchasing programs.
And it is clear that while the acronym soup might see the PEPP disappear from the lexicon, the QE programs will continue.
He also introduced a new element, beyond the forward guidance narrative, into the PEPP/QE storyline.
He said:
A second consideration is net bond supply. You cannot think about the volume of the APP independently of the volume of net bond supply. The relatively high fiscal deficits that we saw last year and this year will not be lasting in the coming years, but the scale of deficits may remain higher than the pre-pandemic levels.
And with that you clearly see the tie in between fiscal and 2021-style monetary policy.
Obviously, they can only purchase bonds if they are issued by the Member States, in the case of government debt.
And obviously, the fact is that the rate of bond issuance is determined by the amount of net public spending (deficits).
Smaller deficits, less debt, less QE scope … and, while the ECB won’t admit this, less requirement for QE.
And, he clearly is signalling, that if the fiscal deficits “remain higher than the pre-pandemic levels”, then the likelihood is that the scale of the PEPP/QE purchases will remain higher.
But the point the journalist didn’t try to pursue, which would have been revealing, is – why do the “financing conditions” in the market, which is the ECB’s lame justification for the massive QE programs, depend on the size of fiscal deficits?
The point is that the ECB is clearly accommodating the fiscal choices made by the Member States (given that the purchases are broadly in line with the Member State proportions in the capital key) to ensure that yields remain low and governments are not held to ransom by the private bond markets.
Conclusion
It is interesting that the ECB has been much more explicit in its statements about its QE programs in recent months and also has rejected the mainstream notion that they are likely to result in accelerating inflation.
The last interview was also notable because it more or less tied the scale of the QE programs to the size of the fiscal deficits.
One link away from full disclosure.