Podcast Summary
Europe's Shift to Fiscal Stimulus and its Implications for Monetary Policy: Europe is implementing a €750 billion recovery fund to boost its economy, marking a shift towards more fiscal policy. This raises questions about the future role of the European Central Bank in monetary policy.
Europe is making significant strides in addressing the economic challenges posed by the current crisis through fiscal stimulus measures, with the EU announcing a €750 billion recovery fund for the eurozone. This marks a shift from past criticisms of insufficient fiscal policy within the euro system. The arrival of fiscal stimulus raises questions about how it will reshape monetary policy and the role of the European Central Bank, which is also in the midst of rethinking its inflation targeting strategy. Victor Stancio, former Vice President of the European Central Bank, joins the Odd Lots podcast to discuss these important issues. While Stancio may miss his executive responsibilities, the current crisis presents important policy making opportunities.
European Economic Recovery Fund: A Milestone in European Fiscal Policy: The €700 billion European recovery fund marks a first in European history, issuing common debt for budget transfers instead of loans, and disproportionately benefiting countries in need. This demonstrates Europe's commitment to supporting members during economic downturns, a crucial step forward in European economic unity.
The €700 billion European recovery fund, established in 2020, marks a significant milestone in European economic history. This is the first time common European debt is being issued, and the funds will be distributed as budget transfers rather than loans. It's also the first major European fiscal policy stimulus to address a recession, and the transfers will disproportionately benefit countries with lower living standards and higher unemployment. These precedents, which include a convergence play and a solidarity aspect, are crucial for the future of the European economy and demonstrate that Europe will support its members during economically challenging times. However, the slow pace of these developments from the outside perspective can be attributed to the initial design of the monetary union, which relied heavily on monetary policy and the private sector. When faced with the economic shocks of 2008 and 2009, there was a lack of preparedness, leading to a double-dip recession. The fear of fiscal policy in member countries and the initial rules in place made it difficult for progress to be made. It took time for the ECB to implement quantitative easing in 2015, but lessons were learned from this episode, and the European recovery fund is a testament to the progress made since then.
Germany's Changing Response to Economic Shocks in Europe: Germany has shifted from prioritizing monetary policy over fiscal intervention to adopting more expansionary fiscal policies due to recent economic shocks and the need for collective responsibility within Europe.
The European response to economic shocks has evolved significantly, particularly in the case of Germany. This change can be attributed to a few factors: the symmetric nature of recent shocks, the need to protect European sovereignty in a complex geopolitical landscape, and the recognition of the importance of fiscal policy in response to both short-term crises and long-term economic stagnation. Germany's resistance to fiscal spending was rooted in its domestic ordoliberal approach, which prioritized monetary policy over fiscal intervention. However, the financial crisis and the COVID-19 pandemic forced Germany to reconsider this stance and adopt more expansionary fiscal policies. This shift marks a new awareness of the importance of collective responsibility and cohesion within Europe, which is crucial for maintaining the monetary union and the euro. While this does not guarantee the imminent establishment of a fiscal union or other institutional reforms, it does represent a significant change in mindset that will likely influence future responses to economic shocks.
EU's €750bn recovery plan focuses on public investment and green initiatives: The EU's €750bn recovery plan prioritizes public investment, with a large allocation for green projects, to promote long-term economic recovery and stimulate demand. Central banking and fiscal policy are now coordinating to stabilize markets and support income and firm survival.
The European Union's €750 billion recovery plan focuses on public investment, with a significant portion dedicated to green initiatives to combat climate change. This fiscal stimulus is expected to promote long-term economic recovery and stimulate aggregate demand. Central banking and fiscal policy are now working in tandem, with central banks stabilizing financial markets and fiscal policy addressing income and firm survival during economic downturns. However, the true test of this new relationship will come when inflation rises, and central banks must respond. The collaboration between monetary and fiscal policy may vary among countries. Overall, the EU's recovery plan reflects a shift towards a more active role for fiscal policy in economic recovery.
The relationship between monetary policy and inflation is complex: Central banks can't control inflation solely through monetary policy, it's influenced by various factors including fiscal policy, external shocks, and expectations.
The relationship between monetary policy and inflation is more complex than what was once believed. Milton Friedman's theory that inflation is always and everywhere a monetary phenomenon and that central banks can control inflation through monetary aggregates has been debunked. Inflation is influenced by various factors including fiscal policy, external shocks, and expectations. Central banks, such as the ECB and the Fed, have not engaged in full-fledged monetary financing, despite media reports to the contrary. The Bank of Japan's experience of buying over 100% of its GDP in Japanese public debt to combat deflation but failing to achieve inflation is a testament to this. Inflation forecasting models now take into account various drivers, including import prices, exchange rates, cost shocks, and economic agents' expectations and inertia. The initial Phillips curve, which was a simple relationship between wages and unemployment, has collapsed, and a more complex way of forecasting inflation, called Phillips curves, still includes the slack in the economy but is not the only factor. Globalization and the entry of billions of low-wage workers from Asia have put significant pressure on declining prices of industrial products, making it difficult for domestic slack to control inflation alone.
Central banks' role in preventing deflation and maintaining price stability: Central banks have a primary role in maintaining price stability and preventing deflation, but their mandate can expand to include secondary goals like climate change and inequality.
While central banks don't have unlimited control over inflation, they have played a crucial role in preventing deflation in advanced economies, except for Japan. Central banks can expand their mandate to include goals like climate change and inequality, but these should be secondary to their primary objectives of maintaining price stability and promoting economic growth. Monetary policy can have an impact on inequality through its effect on asset prices and employment, but it cannot solve all economic issues. Other public authorities, such as governments, are better equipped to address concerns like climate change and the fate of weak companies.
Banks supporting weaker firms without impacting good firms' access to credit: Central banks should focus on maintaining liquidity and capital in the banking system, while keeping an eye on subordinated concerns but not prioritizing them.
The current economic situation allows banks to support weaker firms without hindering their ability to provide credit to good firms looking to invest and expand. Central banks should consider keeping an eye on subordinated concerns, but not prioritize them over maintaining liquidity and capital in the banking system. Regarding the ECB's inflation target, there's a debate about whether making it flexible could make it a political choice. While some argue that a flexible target could allow the central bank to respond to economic shocks, others worry it could undermine its independence. The speaker suggests that a symmetric inflation target, which allows for slight deviations, is the best approach. An interesting point raised was that if the US were to adopt an overshoot or catch-up inflation strategy, it could influence other central banks, including the ECB. Change in central bank policies can occur through new ideas, discussions, or the composition of the central bank members.
ECB and other central banks to adopt more accommodative monetary policy: ECB acknowledges influence but can't fully control long-term interest rates, uncertainty around Europe's economic recovery calls for potential additional stimulus
The ECB, along with other major central banks, is expected to adopt a more accommodative monetary policy in the aftermath of the COVID-19 crisis. This shift is justified by the anticipated economic scars and prolonged unemployment. Central banks, including the ECB, influence short-term and medium-term interest rates, but they don't have full control over long-term rates due to market factors and the size of financial markets. The current environment has led to criticism of central banks for perceived erosion of savings and potential inflation. Central banks acknowledge their influence but admit they don't have complete control over interest rates across the maturity spectrum. Regarding Europe's current economic situation, it's uncertain if the existing fiscal package and monetary policy will be sufficient to restore the economy to its pre-crisis state in a reasonable timeframe. Depending on the virus situation and the possibility of a second wave, additional stimulus might be necessary.
European economic recovery will be slow due to decreased demand, deficits, and consumer savings: Europe's economic recovery from COVID-19 will be slow due to decreased demand for certain sectors, increased government deficits and potential loan defaults, and consumers saving more for an extended period. Central banks are shifting towards supporting fiscal stimulus, but the interaction between monetary and fiscal policy is uncertain.
The European economic recovery from the COVID-19 crisis will be sluggish due to structural decreases in demand for certain sectors, increased deficits from government guarantees and potential loan defaults, and consumers saving more for an extended period. Central banking and monetary policy are shifting towards a more supportive role for fiscal stimulus, but the interaction between the two remains uncertain. Economists continue to grapple with significant uncertainties regarding key economic concepts, such as inflation and the natural rate of interest.
Challenges in Measuring Inflation and Understanding Its Drivers: Central banks struggle to reach inflation targets due to debates over inflation's causes and measurements. Milton Friedman's theories don't always hold true, and ongoing research is necessary to grasp this economic concept.
Central banks, including the European Central Bank (ECB), face challenges in achieving their mandated inflation targets, as there is ongoing debate about what drives inflation and how it should be measured. Milton Friedman's theories about inflation, such as the relationship between government debt and inflation, have not always held true. The ongoing discussion about inflation and its measurement highlights the complexity and ongoing research required in understanding this economic concept. Despite persistent under-targeted inflation, many people in Europe argue that living costs are increasing. The intricacies of inflation and its measurement are worth exploring further, making it a fascinating topic for continued study. The Odd Lots podcast hosts, Tracy Alloway and Joe Weisenthal, mentioned an upcoming inflation series and encouraged listeners to follow their guests and co-hosts on social media. Additionally, Bloomberg is launching a new podcast, Money Stuff, where Matt Levine and Katie Greifelt will discuss finance and related topics every Friday.
