It is Wednesday and I am doing the final corrections to our Macroeconomics textbook manuscript before it goes off to the ‘printers’ for publication in March 2019. It has been a long haul and I can say that writing a textbook is much harder than writing a monograph not only because the latter are more exciting in the drafting phase. The attention to detail in a textbook that runs over 600 pages is quite taxing. Anyway, that is taking my attention today. I also plan to write some more about Brexit in the coming weeks and Japan (tomorrow). But today, I have updated some ECB data on household and corporate borrowing and the cost of borrowing to see what sort of recovery is going on. With nations such as Germany now recording negative growth in the third-quarter, it is clear that the Eurozone is stalling again. The explanation doesn’t require any rocket science. It is all there in the behaviour of the non-government sector (saving more overall) and fiscal rules that are too tight to offset that saving desire. The reliance on monetary policy is an ineffective tool to provide the offset in non-government saving overall. Fiscal policy has to be reinstated to the primary position and that means nations such as Italy must consider exiting the dysfunctional monetary union that biases nations to recession and stagnation.
Euro bank lending
I was updating my database for some commissioned work I have been doing for a Eurozone institution today.
I won’t go into detail of the work but the summary results of some of it are interesting.
I last wrote about this data in this blog post – The ECB could stand on its head and not have much impact (February 2, 2016).
The mainstream New Keynesian macroeconomics logic that a reliance on monetary policy for counter-stabilisation does not accord with the forces that drive the economic cycle.
The belief that banks will suddenly lend just because the central bank imposes a tax on their reserve deposits (negative interest rates) or offers them cheap loans to on-lend to households and firms is misplaced.
Banks do not loan out their reserves and firms will not borrow from banks no matter how cheap the money is if there are no profitable opportunities to pursue.
It is time the authorities abandoned their neo-liberal myths and got real.
The Eurozone needs a massive fiscal expansion and it needed it 7 or 8 years ago.
The ECB is the only institution in the flawed system that can provide the financial resources to make that happen and it could, with Brussels approval, bypass the ‘no bailout’ clauses in the Treaty to make that happen.
The Italian situation at present is all down to the flawed institutional structures of the common currency.
The massive Asset Purchase Program (APP) conducted by the ECB is, in reality, funding fiscal deficits in the Eurozone.
Without that program, which is strictly breaking the laws of the Treaties, the Eurozone would have broken up years ago.
The primary buyers of the government debt know with some certainty, given the size of the APP that the ECB will buy the debt they wish to off load.
The ECB, itself, has said that the APP is all about “maintaining price stability” it also says that the program will:
… also help businesses across Europe to enjoy better access to credit, boost investment, create jobs and thus support overall economic growth, which is a precondition for inflation to return to and stabilise at levels close to 2%. Subject to price stability, these are also important objectives to which the ECB contributes in line with the Treaty.
So the ECB wants us to believe that pushing more reserves into the banking system will act as a stimulus measure to lending.
Anyway, I checked the latest data this morning.
The first graph shows the total loans to households and non-financial institutions (that is, businesses that produce goods and services rather than shuffle money) in the Euro area from September 1998 to September 2018 (this is the entire sample provided by the ECB Statistics Warehouse.
The data is not “adjusted for sales and securitisation”, which the ECB define as “Adjustment for the derecognition of loans on the MFI balance sheet on account of their sale or securitisation.” In other words, the risk is sold off to some other speculator or another. They only started making that adjustment in January 2009.
The boom then the crash. While the household credit aggregate is now a little higher than before the crash, business borrowing remains well down and despite the ECB efforts.
The next graph shows the annual percentage change in borrowing by households (upper panel) and non-financial institutions (lower panel) from January 2003 to September 2018. The red lines are the respective cost of borrowing for each sector (which is only available from January 2003).
There you see the credit binge in both sectors prior to the crisis and the subsequent collapse.
The growth rate in household loans is now falling even though the cost of borrowing is also falling and the response by corporations is weak, to say the least.
Now consider the following Table which is taken from Fig. 1 in the November 20, 2018 Nomura Briefing from Richard Koo (not available publicly).
It shows the “changes in private-sector savings in various economies before and after the GFC erupted in September 2008”.
Richard Koo writes that:
The table makes it clear that the private sectors in both the US and the eurozone have been running large financial surpluses ever since the housing bubbles burst. In the eurozone, this surplus has averaged 4.81% of GDP from 2008 Q4 to the present.
He is referring to the private domestic sector.
Now unless that private domestic is offset either by an external surplus and/or a public deficit, real GDP growth will decline and unemployment will be higher than otherwise.
These private surpluses are why borrowing in the Euro area has been so weak.
The importance of thinking in this way is to allow one to reach an understanding of how damaging the Eurozone fiscal rules have been (Stability and Growth Pact and then the stricter Fiscal Compact).
Richard Koo writes:
… the Maastricht Treaty’s 3% deficit cap and the 2013 Fiscal Compact have prevented governments from implementing the fiscal stimulus needed to borrow and spend this 4.81% surplus. Any private-sector savings in excess of the deficit simply dropped out of the income cycle, prompting sustained weakness in the eurozone economy.
Which is true for the Eurozone but only partially true for a currency-issuing government such as the US, UK, Japan, Australia etc.
The difference lies in the phrase “needed to borrow”.
For a currency-issuing government, the government doesn’t need to borrow these savings. What it needs to do is to make sure they are offset by spending, after adjusting for an external balance reality.
So in the case of most nations, which run external deficits, the fiscal deficit has to not only offset the drain in spending from the external sector, but also the overall private domestic saving.
Otherwise, you get recession and stagnation.
In the Eurozone, the governments do have to borrow in order to run deficits because they unwisely opted to use a foreign currency, the euro.
And the fiscal rules are so restrictive that these governments are unable to borrow enough and spend enough, with the result being their poor economic performance with elevated levels of unemployment.
The Eurozone can never be successful on a sustained basis while these rules are in place and operational.
That is why countries like Italy must break out and restore their monetary sovereignty.
And don’t buy the stupid line that monetary sovereignty is about being able to buy everything a nation might need to be prosperous. Being in that position is a different state altogether.
Monetary sovereignty means that the currency-issuing government can purchase anything that is available for sale in that currency including all idle labour. So no productive resources ever need to be idle if they are looking to be used.
That doesn’t mean a poor country will be rich! That is a different thing altogether.
Given the scale of the monetary policy interventions over the last year or two one would have expected a much stronger growth in loans, particularly for non-financial institutions if the logic of the central bank was sound.
The central bank can clearly use its currency-issuing capacity to prevent a massive financial meltdown. It can clearly stop governments in the Eurozone from going bankrupt as it did between 2010 and 2012 with the Securities Markets Program.
But what monetary policy in any of its forms cannot do is reverse a major recession where mass unemployment and income losses create deep pessimism among households and firms.
Monetary policy does not work to offset non-government saving in the way that fiscal policy does.
This is especially the case where the relevant fiscal authority (a questionable term in the case of the Eurozone) is intent on maintaining a straitjacket of austerity, which chokes off any green shoots in economic activity.
The big motor is fiscal policy and because of the flawed design in the Eurozone it is dysfunctional in the extreme. Central bank policy shifts can do little to counter the damage that fiscal austerity is doing in Europe.
Music I am listening to as I work today …
Its funky, its jazzy and its reggae – how could one go wrong?
It often turns up on my play list.
Something good coming out of America!
That is enough for today!
(c) Copyright 2018 William Mitchell. All Rights Reserved.