Editorial

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.