Thursday, 15 April 2010


"...when to start tightening monetary policy... :

1. Don't wait too long, especially if the signs of recovery are apparent and interest rates are at very low levels. The sooner tightening starts, the less tightening might be needed later on.

2. To be sure, don’t wait to see inflation rising before raising rates. It will be too late.

3. Use a wide set of indicators and arguments to explain to market participants and the public at large why tightening is needed. Money and credit aggregates, asset prices and the level of interest rates might be useful indicators of why the time has come to reduce accommodation.

I leave it to you to judge how valid these recommendations are for the current conjuncture.", Bini Smaghi
I don't know why but when I read the paragraph above, I read it as a clear signal that the ECB is preparing to tighten the monetary conditions...not because we have a robust and sounds growth in Europe - far from that - but simply because of external factors that may force the ECB to raise interest rates earlier than anticipated in order to anchor inflation expectation.

What are the external factors?
- an imminent reevaluation of the chinese currency,
- a rise of the oil price (more than 70% in a year),
- and overheating of the new world engine: the emerging markets.

Would the ECB allow to let inflation go out of control - as some suggest - in order to reduce the burden of debt on European states? let's get the answer for the future ECB president (2011) - jurgen Stark:
"let me stress that any call to reduce the real value of public debt through higher inflation will be firmly opposed by the ECB. A low and stable level of inflation is a prerequisite for confidence, stability and sustainable growth."


Andrew said...

with greece on the point of default i doubt rates are going to rise.

HousingFinland said...

You are right Andrew, The ECB is in a difficult position...but at the end of the day, its monetary policies are driven to fit Germany, France , Spain and Italy ... the rest will need to adapt even if it mean aknowledging high deflation in those countries.

If it was Spain that would be in the shoes of Greece today (which could happen next, who knows - that would be terrible) than then the Eurozone will be for very tough time.

So if there are signs that Germany experience some inflationnary signs (do not forget that they are big exporter to China etc...) and if at the same time, China India keep on overheating... then the ECB will be forced to raise interest rates to be credible.

Failing to do so would mean as said by Bini Smaghi a more painfull tightening cycle - maybe similar to the late eighties in the US where Volcker as to raise interest rates to record level... But I don't believe in such scenario since I think the ECB, is pretty smart, and they know what is at stake - credibiliry, confidence and honesty - values that are at the core of the EURO.

Now Finland would a collateral damage - no doubt sine at the moment we are clearly experiencing a divergence between houshold income growth and housing price growth...typical at the end a bubble.

By collateral damage, it would mean that deflation would be the only exit to bring back competitiveness and affordability ... something long lost in Finland (ask for example the Wood industry, The IT industry, etc...)

Andrew said...

it is a mess.

Even the German finance minister is calling for Greece to get more help even before they get any help:

Schäuble: [W]e have experienced a financial crisis from which we in Europe must draw a clear lesson: We cannot allow the bankruptcy of a euro member state like Greece to turn into a second Lehman Brothers.

Spiegel: You are exaggerating. In past years, it's happened again and again that a country couldn't pay its debts, and yet that hasn't led to a collapse of the global financial system. Why should this be different in Greece's case?

Schäuble: Because Greece is a member of the European monetary union. Greece's debts are all denominated in euros, but it isn't clear who holds how much of those debts. For that reason, the consequences of a national bankruptcy would be incalculable. Greece is just as systemically important as a major bank.

I think what he means is that Germany holds many of those debts or is counterparty to somebody who does hold many of those debts. Ie Germany wants a bailout.

Bailouts are good! Think of all the Finnish and german production that more than 30 billion can buy and the nice club med holidays those rich northerners will be able to pay for.

Andrew said...

So it seems french and german banks have got Greek bonds and they have deposited these with the ECB in return for euros and the ECB has extended a while back to one year the amount of time these bonds will be held. And probably it is a formality to roll them over providing Greece does not default. So obviously the ECB does not want Greece to default which then means that somehow the cronies of the banks in government have to get a bailout to save the banks with most exposure. If there is no bailout the banks will fail and be publicly owned. Obviously the banks want more bailouts without losing profits ect. Weber is saying Greece needs more money but the governments are not going to buy the bonds which i would guess means greece will default and the banks will fail. Trichet says it is unthinkable that Greece will default. The ECB could just monetize all the debt by just sitting on the bonds for all time. If so the banks will be fine the banks government cronies will be fine and ordinary people will all be climbing over each other to get paid more to eat as inflation erodes their income. All fairly 1970's. In Finland it seems everybody has already been on strike at least once in the last year.

Portugal meanwhile observing all of this is not cutting back much on its spending and the general idea of the day around the world is 'spend your way to prosperity'.

HousingFinland said...

"In Finland it seems everybody has already been on strike at least once in the last year."

To get what : 0.5% to 1.5% ?

I think we are far from the 10% increase (every quarter?) of the 70's 'cause the production would then go to the emerging market...

At the end Europe can go on only consuming and not producing...Deflation is the solution and so will be the faith for Greece, Estonia, Latvia...and other will follow suit.

Higher inflation...just think about the fact that interest rates are almost equal to zero, government deficit on exponential rise and yet inflation with deflating or stagnating income...

While the capacity in emerging market is not shrinking but incresing as to absorb an extraordinary amount of workforce ("The emergent")...while on the other side we have an ever rapidly shrinking consuming population ("the Rich")

Andrew said...

what is falling in price?

Anonymous said...

I see the price of greek bonds deflated by 10%.

And now i suppose Finnish taxpayers are going to be paying the interest going to the german and french banks who are being bailed out when our leaders tell us it is in our interest that we support our friends in need.

Billpete002 said...

Prices aren't falling because of the extreme amounts of cash that are being dumped into the system - thus keeping prices steady (since there is such a strong deflationary wind even dumping tons of money and having rates at near 0 for almost a year hasn't caused prices to rise.)

Right now we are in limbo - the bad loans, extreme amounts of wasted spending, and other economic tragedies are just being delayed - and ultimately being made worse via Keynesian economics.

HousingFinland said...

Billpete has captured pretty well what I tried to say.

"What is falling in price"

Income are not rising very much - union are pretty weak - since they can manage to hold more than a few days of strike for no much benefits - it looks like the union are playing politicians technique with their members maybe to give the illusion that they have some power over the industry - The industry/state crushed the union during the last 1990 recession.

Now while income are not rising - interest rates are bound to rise if not at the end of this year , next year most probably - unless you have a return to economical trouble which would mean rising unemployement with massive default int he line associated with banking instability. In any case, people suddenly will notice they have to save in order to consume as opposed to previous periods.

At the same time, when interest rates will be higher, people will understand that the current house price are disconnected to the income and affordability... buyers will shrink while supply will grow, on top no big mortgages will be chasing assets... would ultimately mean that the houysing price could readjust proportionnaly to the interest rates adjustment.

Andrew said...

Why do some people so enjoy insulting keynes?? Seems a pretty cheap shot to me

Anyway at the moment i am wondering if the Euro can survive. And what difference if any it will make to our lives up north