Roubini takes on the ECB

April 23, 2012

It was fun to watch. Nouriel Roubini, NYU economist and crisis personality, was one of just five carefully selected individuals at a large gathering in the International Monetary Fund HQ1 building’s towering atrium who actually got to ask questions of the policymakers on stage.

Roubini was characteristically biting in his critique of conventional orthodoxy, singling out the European Central Bank for not having done enough to stem the euro zone’s two-year financial crisis. He challenged the notion that the ECB is powerless to boost growth further, suggesting — to the clear discomfort of some policymakers in the room — that measures to weaken the currency could provide a badly-needed boost to exports:

I saw that on the panel there are four central bankers and the panel is about fiscal policy and sovereign debt. So the natural question is then to think maybe about what could be the contribution of central banks in resolving sovereign debt issues. Now, one simple answer would be to just monetize very large budget deficits and I understand why a central bank would say that’s a no-no.

But there’s a more subtle argument and it’s the following one: we know that while fiscal austerity is necessary, in the short-run, as even Christine Lagarde said and the IMF’s work suggests, that has a net recessionary effect on the economy. You’re raising taxes, you’re reducing transfer payments, you’re reducing government spending, so you’re reducing disposable income, you’re reducing aggregate demand. It makes the recession worse and you can get a vicious circle. Not only do you have deleveraging of the public sector but the raising of taxes and cutting of transfer payments induces also deleveraging of the private sector.

So if domestic demand is going to be anemic and weak in this fiscal adjustment because of private and public sector deleveraging you need net exports to improve to restore growth. That’s what happened in emerging market crises. But in order to have an improvement in net exports you need a weaker currency and a much more easy monetary policy to help induce that nominal and real depreciation that is not occurring right now in the euro zone. That’s one of the reasons why we’re getting a recession that’s even more severe. So, can’t we think of monetary policy as helping to induce the change in relative prices that’s necessary to have a restoration of growth if domestic demand is weak through net export improvements?

Roubini was not alone in his critique either, with the ECB coming under pressure from the IMF itself to lower rates further.

ECB Vice President Vítor Constâncio responded by stressing the institution’s price stability mandate as well as the difficulties of synchronizing policy for a group of nations growing at different speeds:

We have only one monetary policy for the average of the euro area. Headline inflation is now at 2.7 (percent). We anticipate, and we have reasons to trust the forecast that inflation in the euro area will be below 2 at the beginning of next year. Nevertheless it’s about 2. Even if you consider core inflation, it’s now at 1.6 – so it’s clearly not in any way a deflation risk. And this would be the reason for us to have a different monetary policy than the one we have now, because that would be directly connected with our mandate regarding price stability in both directions. But that’s not the case right now.

So your implicit view, or recommendation if I may draw that from your question, really would fit much better, even appropriately, with the mandate of the Fed but it’s not what we have in the ECB.

Nevertheless we are doing a lot in view of the situation that inflation expectations are very firmly anchored. That has allowed us to do lots of things. We rely and trust that in the present situation with a weak economy we can be sure of complying with our primary objective so we can do other things and we have done that – but not what you hinted at.

Bank of France Governor Christian Noyer, who was hosting and moderating the event, had spoken about that very same subject earlier during the panel discussion. Like Constâncio, he argued markets should not expect central banks to shoulder too great a burden:

The demands on all major central banks have grown, (and brought about) considerable (shifts) in operational frameworks and a very significant expansion of their policy instruments. There is a tendency among certain market participants and certain policymakers to consider the central banks as universal problem solvers whose balance sheet can be used without cost for all sorts of purposes.

There is also a doubt … in the minds of some analysts about the true objectives of some of the central banks’ interventions such as public bond purchases. And real or perceived fiscal dominance may be seen as possible. In the situation where we are today, we may have to live with a combination of high public debt and unconventional monetary policy measures for some period of time and monetary policy will likely for some time rely on a diversity of instruments. And also, macroprudential measures will interact with monetary policy in a complex way. In this complex situation what I believe is absolutely needed is clarity on the objectives and robustness on the policy frameworks.

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