20 December 2011

Ronald Janssen: It takes a (European) Central Banker to understand one

The traditional central banking thinking is that monetary policy is simply a 'veil' without much of an impact on what is happening in the real economy. Reality, however, is quite different and measures taken by the ECB have substantially impacted upon the (re)distribution of income within but also amongst Member States.

In the aftermath of the most recent European Council, there was an avalanche of public statements which, in effect, put the Council’s policy package into serious doubt. One statement in particular deserves further analysis. In an interview with Frankfurter Allgemeine Sonntagszeitung on the 11th of December, Bundesbank president, Jens Weidmann, expressed the view that the ECB cannot mobilise its financial firepower to stabilise the sovereign debt markets because "monetary policy has no mandate to redistribute amongst the tax payers of the Member States".

Interest rate cuts are usually seen as the central bank’s reaction to an economic slowdown. There is, however, an additional dimension to it. More than just trying to prop up aggregate demand in a general way, what a central bank does in an economic downturn is to start up the money printing press for the banks. Banks are offered higher liquidity at much lower costs. While the idea is that banks would pass this increased liquidity to the rest of the economy, the banking sector interest margins also widen since they can get money from the central bank at low interest rates and invest it in bonds or mortgages carrying substantially higher interest rates.

This logic was intensively applied during and after the 2009 financial crisis, with banks getting unlimited access to the ECB’s liquidity at an interest rate of only 1 per cent. The irony is that monetary policy, by saving the economy from depression, also secured the profits and the interests of a sector whose practices are at the origin of the financial crisis, with these profits being reflected in the banking sector continuing its practice of excessive bonuses. It is highly disturbing that the ECB hardly used the leverage it had to push for structural reforms on the banking sector. The ECB may have given the ‘friendly’ advice to European banks to inject the billions of profits they were making thanks to the ECB’s policy into stronger capital buffers instead of paying out (higher) dividends, but that was it. The banks, by getting access to the ECB’s vast and cheap liquidity, were, basically, given a ‘free lunch’.

Now compare this with the ECB’s attitude towards governments where there is a ‘hands on’ policy. Support for sovereign debt is only forthcoming in a piecemeal way (enough to prevent an immediate collapse of the euro, but not enough to end speculation) and only in exchange for brutal conditionalities implementing tough austerity measures and wage cuts, with these measures having a direct but perverse impact on income distribution.

The bottom line is that monetary policy always has distributional effects. European monetary union is no exception. What seems to be the real particularity in the European monetary union is that its central bankers, such as Jens Weidman, have no problem with ‘redistribution’ when such redistribution is done by the markets and the banks while the process of distribution that is organised by welfare states and well-developed wage bargaining systems is being forcefully rejected, even if this comes at the price of the economy and the euro area collapsing.

Full article

© Project Syndicate