The
ECB’s Governing Council has a specific approach to determining the nature and
extent of the risks to price stability in the euro area over the medium term.
This approach for assessing the risks to price stability is based on two
complementary perspectives, known as the two “pillars”:
·
Economic
analysis
·
Monetary
analysis.
Economic analysis.
The
European community is facing a liquidity trap. A liquidity trap is a situation
when expansionary monetary policy. A policy by monetary authorities (the ECB) to
expand money supply and boost economic activity, mainly by keeping interest
rates low to encourage borrowing by companies, individuals and banks does not
stimulate economic growth.
Efforts
to stimulate the Eurozone economy by the lowering of interest rates and the buying
of government debt through the Outright Monetary Transactions in the secondary
bond markets (A market where investors purchase securities or assets from other
investors, rather than from issuing companies themselves.) and the sovereign
bond markets (where government bonds are traded) which is aimed at bringing
bond yields, at the long end of the curve (i.e. 10 years) down to levels that
lower borrowing costs for countries that face problems gaining funding from the
markets due to their high bond rates is not showing favourable market reaction.
Lowering
of the interest rate when there is a liquidity trap is pointless. When in a
liquidity trap what you really need is a negative interest rate, so to
encourage people to spend money, banks to lend and business to take risks.
The
buying of government bonds which is not quantitative easing, since no new money
is being created in real terms because when the ECB buys bonds from banks it
does so by crediting those banks’ accounts at the ECB with reserves that didn’t
exist before. It is misleading to call this process “money printing” because it
doesn’t actually do anything to increase the amount of money in circulation.
We
purpose that we lower the interest rate (MRO- Main refinancing operations) a further 25 base points (A unit that is
equal to 1/100th of 1%) and we introduce the producers of free/accelerated
money until the point comes when the liquidity trap is broken. A liquidity trap
is terminated when monetary policy instrument of interest rates cuts bears
effect on the economy.
Gesell
Money creates a form of artificial inflation by gradually reducing the face
value of the currency itself. This allows the ECB to bring the nominal interest
rate (The
interest rate before taking inflation into account) of the paper currency to
less than zero.
In
the short-run, this negative real interest rate will increase aggregate domestic
demand. (The total amount of goods and services demanded in the economy at a
given overall price level and in a given time period.) This increase in
aggregate domestic demand will create an output gap which in turn accelerates
inflation, there go the Euro would devalue, and therefore exports would become
cheaper thus more competitive to foreign buyers. This provides a boost for
exports and a lessening of debt burden.
Higher
level of exports should lead to an improvement in the current account (day to
day income and expenditure) deficits. Higher exports coupled with increased
aggregate demand can lead to higher rates of economic growth.
Hence the liquidity trap is sprung through the
increase in domestic demand for domestic output in a Eurozone context (Your spending is
my income) without having to resort to expensive expansionary fiscal policies.
The
‘accelerated money’ mechanics would work as follows
90%
of what we call "money" are numbers in a computer. Thus, everyone
would have two accounts: one current account and one savings account. The money
in the current account, which is at the disposal of the owner continually,
would be treated like as a self-devaluing asset (it deprecates in value) and
might lose as little as 0.5 % per month or 6% per year thus encouraging people
to spend.
Very little would change in practice. Banks would
operate as usual, except that they would be more interested in giving loans
because they too would be subject to the same use fee that everybody else would
have to pay. However they would be under strict regulations.
In order to balance the amount of credit and savings
available temporarily, banks might have to pay or receive a small amount of
interest depending on whether or not they had more new money in saving accounts
than they needed or whether they had liquidity problems.
When
enough new money has been created to break the liquidity trap, no more would
have to be produced. Therefore the new money would then follow a
"natural" physical growth pattern, meaning in blunt sense it would
work its way out of the system because it would devalue to zero and no longer
follow an exponential growth pattern. Exponential growth is when given enough
time, compound interest can theoretically turn even a relatively small amount
of principal into a very large sum.
Another
technical aspect of the implementation of such a monetary reform includes the
prevention of hoarding cash. The solution would be the printing of different
coloured banknotes so that various series could be recalled once or twice a
year, without prior announcement. This would be no more expensive for a central
bank of a country than the replacement of old worn-out banknotes by new ones.
This
would be seen as a longer-term liquidity provision, a non-standard monetary
policy measure.
Monetary
analysis
Once
we have broken the liquidity trap in the Eurozone we can then focus on
alleviating the debt in the economy, correcting the paradox of thrift
This
will be achieved by widening the remit of the OMT (Outright Monetary
Transactions).
We
propose that we buy
long term bonds i.e. 10 year bonds.
No inflation will be created by this procedure
because these transactions are sterile.ie it is giving out money with one hand
and taking the same amount in with the other.
We
should lax the term and conditions that govern the criteria a government must
accept in order to participate in these transactions. They must not have to
follow an austerity programme. The purpose of the transactions must be to
alleviate debt in order to facilitate stimulus in the economy, not as a tool to
lower to budget deficits.
That
is where we have a problem with the Fiscal Compact of which a country must sign
up to in order to gain access to the OMT
programme .Although its rules do not apply during the OMT period a country must
apply it rules as stated below, as soon, if not immediately after leaving the
programme.
Under the Fiscal Compact, a country must
undertake a bi- monthly surveillance of a governmentally independent fiscal
advisory council, which shall guarantee their national budget be in balance or
surplus under the treaty's definition.
The
treaty defines a balanced budget as a general budget (year to year expenditure)
deficit less than 3.0% of the gross domestic product (GDP) (The monetary value
of all the finished goods and services produced within a country's borders in a
specific time period) and a structural deficit. A structural (permanent)
deficit differs from a cyclical deficit.
A
cyclical (temporary) deficit is a deficit that is related to the business or
economic cycle. The business cycle is the period of time it takes for an
economy to move from expansion to contraction, until it begins to expand again.
A
structural (permanent) deficit exists regardless of the point in the business
cycle due to an underlying imbalance in government revenues and expenditures of
less than 1.0% of GDP if the debt-to-GDP ratio is significantly below 60% -or
else it shall be below 0.5% of GDP.
If
we are truly a single currency then when an area is suffering financial difficulty
it should be given the space to get itself back to economic prosperity and not be burdened paying
back its debt.
This
especially applies in a European case since it was the movement of capital (no
capital controls) from the core (Germany, France) to the peripheral (Spain,
Portugal, and Ireland), that caused states to gain these deficits.
The
flow of capital into a country is measured by its current account deficit; a
negative current account deficit means that the country is the recipient of
international lending, while a surplus indicates that capital is being invested
abroad.
Ireland’s
current account was -5.3% of GDP on 31/12/2007 whereas Germany’s was 7.4% of
GDP 31/12/2007.
Money was lent by the core to the peripheral countries
and in turn the peripheral countries brought core exports. The peripheral
counties then became uncompetitive and situation deteriorated.
As
the economist Jacques Rueff said
“If I had an agreement with my tailor that
whatever money I pay him, he returns to me in a loan the very same day, I would
have no objection to ordering more suits from him.”
The
sudden stop in the capital flow, led to the forcing of sovereign states to nationalise
(government buy private assets. An asset is a resource with economic value with
the expectation that it will provide future benefit), the private banking debt
to so to stop the contagion effect (The likelihood that significant economic
changes in one country will spread to other countries) spreading across all of
the European banks notably the core banks.
It
is either restructure the debt repayments in a real scenes not like the
LTRO-Long term Refinancing Operation which have a maturity of three months known
as “trash for cash” because of the widening of what is considered collateral. Frankly
it is not a long term solution because it is like trying to pay off a mortgage
with a credit card.
Or a mass default of the peripheral
countries will happen which will bring the whole European banking sector down
with it.
What
the European countries need is the separation of the banking and sovereign debt
and then for the banking debt to be written off.
The
ECB should then introduce a banking watchdog such as the Single Supervisory
Mechanism (SSM).
The
Directive on Bank Recovery and Resolution (BRRD) and Single Resolution
Mechanism (SRM) being proposed under Article 114 of the Treaty on the
Functioning of the European Union (TFEU) should also be enacted so that
troubled banks from sovereign nations are able to receive bailout funds from
their central bank and therefore not have to nationalised or let fail. The initiative
will limit fragmentation of financial markets and help to guarantee financial
stability.
In
terms of the price stability in the medium term we would not mind if it was to
rise close to the 2% mark because inflation would also encourage people to start
to spend, would bring up the prices of assets and lower debt in a real sense and
combat the deflation we are experiencing at the moment. Inflation was only 0.8%
in December 2013 and fell to 0.7% in January 2014.
This
leads to the price/wage spiral that represents a vicious circle process in
which wages try to keep up with inflation to protect real incomes. This would
not happen in our monetary management because we are not printing money.
When
the ECB creates inflation by printing fiat money (Money that the central bank declares
legal tender), the inflation tricks the markets into increasing production,
which created the illusion of an economic boom.
This
creates a “spiral" of increasing prices and wages. However this can only
continue as long as the central bank continues to intervene in the economy by
inflating the money supply.
Although it could be seen in the case of our
accelerated money theorem that there would be an increase in the total money
supply, however as stated earlier it would be allowed flow the natural flow of
money and work its way out of the system.
In conclusion we propose that the ECB would
lower its interest rates by a further 25 base points to 0 and through accelerated
money injected into the Eurozone system the liquidity trap would be broken.
