Could you give us an overall assessment of the handling the European crisis so far? What has been done? Where things have gone wrong?
I think there was a misdiagnosis of the crisis from the start, it was seen as primarily a fiscal problem. It is true that the crisis had a very prominent fiscal dimension in Greece, but focusing on debt and deficits when at the same time there were severe imbalances between North and South, a banking crisis and a growth crisis led European leaders to put the focus on the wrong place – on what has come to be called austerity – while neglecting the need to address the imbalances, fix the banking system and get growth going again.
There was a reluctance to acknowledge the need for debt restructuring; the decision to restructure debt in Greece was unduly delayed. This was both because the Greek government was reluctant to acknowledge the need for debt restructuring, but even more importantly, because the IMF and the other members of the troika were reluctant to acknowledge the need. So when restructuring finally occurred, it came too late and exempted the official creditors. Eurozone policy is now beginning to move in the right direction with an acknowledgement of the need for debt restructuring, with an effort to address the problems of the banks through banking union and by relaxing the fiscal policy requirements – by giving countries for example two more years to meet their deficits targets – but I think this is too little and too late. That’s the bottom line: if you ask me how I would characterize the policy response, I would say too little, too late.
Is part of the problem the monetary policy followed by the ECB? How you would compare ECB’s policy to what happened in the US, where the FED reacted strongly, launching three rounds of quantitative easing?
Absolutely. The ECB raised interest rates in 2008, when the world was entering the global credit crisis. The ECB was fixated on its 2% inflation target when European economies were entering recession. The failure to use monetary policy more aggressively has been a problem; the failure to address credit market problems has been a serious problem as well. Now, in 2013 five years into the crisis the ECB is beginning to talk about some kind of securities’ market and credit market intervention and about addressing the financing problems of small and medium enterprises. Too little too late, one more time.
One could argue however, that to some degree, this stance by the ECB is dictated by its institutional constraints- its mandate is different from the FED’s. In this respect, what institutional changes would you suggest that need to happen in the Eurozone, in order to be more flexible?
I think there needs to be an acknowledgment that a normal monetary union needs a normal central bank that can act as lender of last resort. The ECB was created as a monetary rule to achieve a 2% inflation target, but I think a modern central bank has to address a range of issues: not only inflation but also financial stability issues and growth issues as well. In the United Stated it took the experience of the Great Depression for the FED to become a normal central bank. I am hopeful that this crisis will be what it takes for the European Central Bank to become a normal central bank.
Do you see any evidence of that?
OMT is an example of that evolution and selective intervention in credit markets would be an example. The ECB won’t will evolve into an institution like the FED overnight, but I do think we will begin to see that evolution. The ECB will have to demonstrate, to the satisfaction of all concerned, that it can carry out these responsibilities prudently and responsibly. And as it does, my hope is that opposition, skepticism and hostility in Germany and elsewhere will begin to dissipate.
On the other hand, some countries have been critisising countries like the US and Japan- accusing them that they pursue a loose monetary policy too aggressively -you have recently written about currency wars and international cooperation- do you think that this charge is justified and is there a right balance that countries should strive for?
No, it is not justified. Appropriate central bank policy depends on the circumstances. But the circumstances at the moment are that the US economy, the UK economy, and the Japanese economy are all weak. So the fact that their central banks are all keeping interests rates near zero and engaging in quantitave easing is appropriate for their conditions. There are two criticisms levied against those policies: first, that they are creating future bubbles; but bubbles are for regulators to address by adjusting loan-to-value ratios in real estate markets or by increasing capital ratios for banks. Second, that the actions of these central banks are having negative implications for other countries, for China, for emerging markets. So, the Chinese complain that when the Japanese central bank is using quantitative easing, it is solving Japan’s problems at China’s expense. But if the complaint in China is that Japanese policy causes funds to flow in the Chinese real estate market, then the solution to that problem is to regulate the Chinese real estate market – not lobbying the Bank of Japan to abandon its policy.
You said before that the FED’s role changed after the crisis in the 1930s. Do you think, in general, that there are valid comparisons between the two crises? In your presentation you made comparisons between two more recent crises, but most people tend to compare the Great Depression with this crisis. Is this a valid comparison?
I do think that there is a valid comparison there, yes, but people are also sometimes prone to misunderstanding the experience of the Great Depression. Currency depreciation and expansionary monetary policy were not the problem in the 1930s. To be sure, there were beggar-thy-neighbour effects when Britain devalued the pound sterling. France found itself with an overvalued exchange rate and deeper recession, but the appropriate response given the deflation of the period, was for the Bank of France to expand. So the problem was not Britain’s initiative to devalue; it was France’s failure to respond in kind. I think the situation is the same now. The policies of the FED, the Bank of England and the Bank of Japan are not creating problems for the Eurozone. It is the failure of the European Central bank to do the same, to respond with easing, that has created problems for the Eurozone. Europe has a recession problem, it does not have an inflation problem; that should enable the ECB to respond easily like other central banks are doing, by cutting its own money.
In any case we still see pressures even within the US- especially in FED’s recent meeting – pressures for this easing to be wound down earlier rather than later. Do you think that this is the right course?
I think that the FED is following the right course by saying that we can’t continue to buy large numbers of securities forever, that we are eventually going to have to exit and that we will do this by gradually reducing securities purchases -that’s what they meaning by “tapering”. They are being prudent by saying that when and how we do this will depend on the data and how strong the economy is.
Monetary policy is always contested, and central banks are always criticized. That’s a healthy state of affairs. I do think that what FED is doing is entirely appropriate under the circumstances.
But if you press me to criticize the FED, I would say that, if anything, it is not being expansionary enough. It is running the risk now of exiting too early rather than too late. But the United States has had a deep-seated suspicion of the monetary power of banks, and central banks in particular, for a long time. That’s why we didn’t have a central bank until 1913, and it’s why, when we created one, it had a federal structure that placed very little power at the center. Americans have long been deeply suspicious of banks and bankers, including central bankers, and there is no reason why it should be different now.
Defenders of austerity in Europe would argue that there are too high levels of debt and fiscal deficits; following an expansionary policy -especially in terms of fiscal policy- would be quite problematic, so the austerity course is the right course to stick to and recovery will come in the long term, mainly through structural reforms. That is basically the German argument. How would you respond to that?
Structural reforms and 1% to 2 % growth might enable the Eurozone to bring its debts down to reasonable levels in two generations. But two generations is a very long period to endure austerity. You can reduce the debt/ GDP ratio, either by reducing the numerator or by increasing the denominator. Regrettably, increasing the denominator does not seem to be an option at the moment. There is no support for raising ECB’s inflation target, and rapid growth is not in the cards. It follows that bringing down the debt can be done in two ways: One is by running primary surpluses for 30 years; and the other one is by restructuring. In terms of restructuring, Greece is an example – a positive example – that other countries can follow. It shows how debt restructuring can be done in an orderly way.
From your last words, I take it that in this recent controversy concerning Reinhart and Rogoff -with regard to the role of debt as a driver for growth- you do not see debt as determining factor by itself.
I don’t think there’s a magical threshold above which debt becomes a drag. Every historical case has its own unique features. Some people point to Ireland in the 1980s and 1990s or the UK in late 1940s and 1950s as examples of countries that could bring their debt/GDP ratios down from well over 90%. If you can increase nominal GDP by 5 %, 6 % or 7% a year then, yes, you can do that. But do you think that Greece can raise its nominal GDP by 8% a year? Another way will have to be found, and that other way is debt restructuring.
Do you see this as politically feasible? Given that now the private sector restructuring has largely taken place and most of the remaining debt is official? How easy is for the Europeans to say, we will concede to writing off debt paid by our taxpayers?
It is much easier to coordinate a small number of official creditors than a large number of private bond holders. But, as you say, there has to be the political will. Once you conclude that the debt of the official sector will not be repaid in full, you have to next ask what is the best way of restructuring it. The answer is that sooner is better than later and doing it in a comprehensive way is better than doing it in a piecemeal way.
In the case of Greece, again, would you be in favor of a second debt restructuring? Given the high level of debt, the fact that the fiscal consolidation is almost over and the most pressing need is now for institutional and structural reforms, what do you think the way forward should be?
I would say to the European Union, to the troika, that official debt has to be restructured because Greece has a debt/ GDP ratio above 150 %. The idea that this can be brought down to 120% any time soon, though any other way, is fictitious. And 120% is too high in any case, for it leaves no room to absorb any kind of negative shock, and we know negative shocks happen.
Beyond that, I think that the troika’s emphasis on structural reform is right. And if the ECB and the European Commission saw Greece moving faster in terms of structural reforms and privatizations, it would be more willing to loosen monetary conditions and do other things that would make life easier for Greece and the other crisis countries. The situation we are in is one where the ECB will not help by loosening, because it fears that help will reduce the pressure for structural reforms and no structural reform will take place. Greece can solve that problem – or Greece together with other crisis countries can solve that problem – by demonstrating that they are willing and able to accelerate the pace of structural reforms. The ECB would then think there is no moral hazard problem here, we can loosen our policy as well, and it should be a win – win situation for everyone concerned.
What about the decline in investment? Even if things play out as planned, when is growth going to come? Eventually the best way out, apart from debt restructuring, is to foster growth and combat unemployment –don’t you agree?
I would make three points about this. One, the collapse of investment and the rise of long-term unemployment, youth unemployment in particular, is doing permanent damage to the growth potential of crisis economies. People who leave school and are not able to find a first good job are worse off, in terms of their economic outcomes, for life. It affects their earning power, their productivity permanently. Structural reforms and more supportive fiscal policies from the ECB and the troika could go someway toward addressing this.
Second, growth cannot come only from exports. The Eurozone as a whole is too big to be able to export its way out of the crisis. Every Eurozone economy is trying to export more to the other Eurozone economies; and that does not add up. Some of the impetus for growth is going to have to come from internal demand and that in turn means there has to be more fiscal policy support.
Third, everyone says that budget deficits need to be reduced and that debts need to be brought down. But there is no reason why this cannot not be done by bigger deficits now and smaller deficits in the future, if the commitment to smaller deficits in the future is credible. The European semester and the two-pack and the six-pack and all those fancy programmes are designed to do that. If the European policy makers believe what they say, that these are robust new policies and that are going to force fiscal discipline in the future, then bigger deficits can be run now by the crisis countries as well as by others, because stronger institutions have been put in place that ensure that these deficits can be eliminated in the medium term. If they are not going to let the GIPS run bigger deficits now, apparently they do not believe that the European semester and the two-pack and the six-pack and all that are really effective.
Europe needs to get out of the crisis, right now. We are now where we are, the mistakes of the past notwithstanding. Some people say that things have started to work, if we just keep on course everything will be fine. Do you find this credible? Do you believe that the relative calm of recent months is sustainable? If not, what should be done right now?
I think that the crisis will be back. Europe has benefited from some exceptional events that are not going to be repeated. First, the announcement of the OMT and then the announcement of the loose monetary policy by the Bank of Japan. The Bank of Japan announced an unexpectedly large programme of quantitative easing on April 4th and European spreads came down and they have come further down by 100 basis points in the following month. There is a lot of Japanese and other money flowing into European financial markets right now, but it is not going to flow forever. So, I think the crisis will return. The only way to address it is through two-handed policies, both supply-side reforms, in other words structural reforms, and demand side reforms, meaning more monetary and fiscal support. If you want to go beyond that, I would say that another critically important focus should be the banking union, because the banks are not lending, the banks are undercapitalized -that is a big drag on the European economy- a banking union with a single supervisor and the ability of the ESM to inject capital directly into the banks would be a big help.
Thank you very much.