Price Stability Is Killing Europe

“The ECB has the clear legal mandate to safeguard price stability. If the central bank were to print money in order to finance the budgets of countries in crisis, it would be unable to fulfil this mandate in the long term. This is because, in the longer term, using the printing press to finance governments leads to higher inflation. Such a monetary financing of governments in the euro area would inevitably jeopardise the euro as a stable currency.”

--Deutsche Bundesbank, “Questions about the sovereign debt crisis”, undated.

“The ECB lacks a coherent strategy for creating the monetary base required to sustain the money creation necessary for a growing economy. The ECB needs to overcome resistance to money creation caused by the link to the debt extinction of governments. The ECB needs to recognize that Europe’s problems are more than structural. It needs to stop using monetary policy as a lever for achieving structural changes and to end its contractionary policy.”

--Robert L. Hetzell,  senior economist, FRB of Richmond, “ECB Monetary Policy in the Recession”, July 2013

“The importance of technical competence in monetary policy has been proved repeatedly by central banks around the world. The quality of monetary policy depends critically on whether central bankers have a clear and nuanced understanding of policy making and inflation. Rather than worrying about inflation, central bankers should focus on reflating the economy.”

--Kenneth S. Rogoff, Harvard University, “The Federal Reserve in a Time For Doves”, August 2013

The ECB has a single mandate, price stability, which is tragic because price stability is killing Europe. Europe needs sustained 4-5% inflation if it is to recover from its five-year depression and reverse its rising debt ratios. But the ECB has defined price stability as inflation of less than 2%. And in addition, the ECB has ruled that a program of QE would violate the prohibition of “monetary financing”, i.e., deficit monetization. This suggests that the central bank can only buy the bonds of governments when they are running budget surpluses!

Achieving 4-5% inflation would require the ECB to buy something (the policy instrument). The normal policy instrument is government debt. Unfortunately, Brussels issues no debt for the ECB to buy. So the ECB is forced to use the bonds of eurozone governments as its policy instrument. But the ECB has defined the purchase of government bonds by the ECB as “monetary financing”. If buying eurozone government bonds is verboten, then the ECB has no policy instrument, as Hetzel points out.

The fact of the matter is that “monetary financing” is a legitimate monetary policy instrument in the pursuit of economic growth and full employment--even if the government in question is running a deficit, indeed, especially if the government is running a deficit, because inadequate growth causes deficits (and rising debt ratios).

So Europe has thrown up two roadblocks to European recovery: (1) zero inflation; and (2) no QE. Europe lacks a coherent monetary strategy, as Hetzel says.