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Eurozone interest rates thread

by Jerome a Paris Thu Dec 1st, 2005 at 06:50:30 AM EST

I write this a couple of hours before the European Central Bank is due to announce what is expected to be the first increase in its main interest rate in almost 3 years, from 2% to 2.25%. Update [2005-12-1 8:25:59 by Jerome a Paris]: This is indeed what it has done. The euro is down half a percent against the dollar.

There has been a lively debate whether this is justified (to fight inflation) or premature (it risks killing off the current tentative growth recovery in the eurozone).

On the hawkish side: the Economist (Why Europe's monetary policy needs to tighten and Japan's doesn't), the WSJ (sorry, no link) and, slightly surprisingly, Le Monde (One quarter point is enough).

On the doveish side, most of the economy and finance ministers of the eurozone and, also slightly surprisingly, the Financial Times (Martin Wolf: Caution would endanger a recovery).

So, what's your take? I have put up a few interesting graphs below the fold to help you decide!.


From an earlier article in the Economist (Haughty indifference, or masterly inactivity? - Monetary policy in the euro area has been looser than critics think):

A widely used test of the tightness of monetary policy is the Taylor rule, which calculates the “correct” interest rate according to the amount of spare capacity in the economy and the deviation of inflation from its desired target. What does it say about interest rates in the euro area? Calculations by David Mackie, of J.P. Morgan, show that virtually throughout the past six years, interest rates in the euro area have been lower than a Taylor rule would have prescribed (see right-hand chart), refuting the popular wisdom that the ECB cares less about growth than does the Fed.

The graph provided in the Martin Wolf article linked above suggests the same:

Real interest rates have been negative in Europe in the last couple of years, which is hardly a sign of a hardline Central Bank.

The market consensus seems to be that the ECB will increase rates to 2.5% (i.e. another increase after today's) in 2006, and will stop there, a small sign of hawkishness agaisnt inflation, but hardly enough to cause any economic pain, and I think this would be a reasonable thing to do.

Display:
I was a little surprised when I heard the news on the radio this morning. The reason cited was to do with high fuel costs: I could not see the connection myself.

Money is a sign of Poverty - Culture Saying
by RogueTrooper on Thu Dec 1st, 2005 at 07:07:40 AM EST
What stands out from the graphs is not any strange behaviour by the ECB, but the 5-year dip in US interest rates (including having the "real interest rate" below -1.0% for all of 2003 and 2004.

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman
by Carrie (migeru at eurotrib dot com) on Thu Dec 1st, 2005 at 07:11:28 AM EST
Greenspan is a God and can do no wrong. And the US economy is growing. And the eurozone is stagnant. and profits are up. etc....

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Thu Dec 1st, 2005 at 07:16:47 AM EST
[ Parent ]
I mean, I didn't realize that Greenspan cut the interest rates by 4.5% over a year. No wonder there was a remortgaging boom!

No wonder it jumstarted the economy and forestalled a recession.

The problem is that, 4 years later, he's increased the interest rates by 2.5% over 18 months. Ouch...


A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman

by Carrie (migeru at eurotrib dot com) on Thu Dec 1st, 2005 at 07:24:35 AM EST
[ Parent ]
From 2002 through 2004 the Fed set a negative interest rate; in effect the Fed was paying banks and major financial institutions to borrow money.  The resulting flood of cash has fueled the housing boom, home equity based consumption, overseas investments in manufacturing, (for reasons I've -tried to- explain elsewhere) and the hollowing of employment opportunities in the US.

She believed in nothing; only her skepticism kept her from being an atheist. -- Jean-Paul Sartre
by ATinNM on Thu Dec 1st, 2005 at 11:39:01 AM EST
[ Parent ]
I have always thought that except for huge changes in the interest rate, when the oscilations are small, the results of a particular policy are just unknown, no matter what people say.

So, I have no clue if 2 % or 3% or 4 % is better or worst..and I doubt anybody could know.

This said, there are good reason to believe that an interest rate at 1% or at 5% would indeed be risky.

A pleasure

I therefore claim to show, not how men think in myths, but how myths operate in men's minds without their being aware of the fact. Levi-Strauss, Claude

by kcurie on Thu Dec 1st, 2005 at 09:19:58 AM EST
I personally believe that all this faith in monetary policy is really not called for. It's a testament to the poor state of economic policies around the world, and especially in Europe, that we have to rely so much on this little number.
by toyg (g.lacava@gmail.com) on Thu Dec 1st, 2005 at 09:51:43 AM EST
[ Parent ]
You receive my first amen. Amen is better than a 4 is personal and warm.

A pleasure

I therefore claim to show, not how men think in myths, but how myths operate in men's minds without their being aware of the fact. Levi-Strauss, Claude

by kcurie on Thu Dec 1st, 2005 at 09:54:24 AM EST
[ Parent ]
are the only things that free-market fundamentalists allow the government to run. And I wouldn't discount the possibility that someone out thre advocates liberalizing the printing of money and "deregulating" whatever flavour of borrowing the central banks' interest rates apply to.

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman
by Carrie (migeru at eurotrib dot com) on Thu Dec 1st, 2005 at 10:05:43 AM EST
[ Parent ]
We actually need a diary or two on the money supply... When you start learning about it it is alternative mind-boggling and worrisome.

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman
by Carrie (migeru at eurotrib dot com) on Thu Dec 1st, 2005 at 01:18:21 PM EST
[ Parent ]
Worrisome only when you finally realize most money does not, in fact, exist except as entries in electronic accounting systems.  Hard money advocates get all bent out of shape about it.  Soft money advocates think hard money advocates are idiots.

My conclusion is both sides have a point and one day, Real Soon Now, I'll write a diary about it.

She believed in nothing; only her skepticism kept her from being an atheist. -- Jean-Paul Sartre

by ATinNM on Thu Dec 1st, 2005 at 05:57:31 PM EST
[ Parent ]
Soft money advocates probably have their wealth in "hard assets", whatever those are.

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman
by Carrie (migeru at eurotrib dot com) on Thu Dec 1st, 2005 at 06:03:34 PM EST
[ Parent ]
Don't think of money as a Noun.  

Think of money as a Verb.

She believed in nothing; only her skepticism kept her from being an atheist. -- Jean-Paul Sartre

by ATinNM on Thu Dec 1st, 2005 at 06:44:14 PM EST
[ Parent ]
I think economists tend to support monetary policy as a stabilization mechanism more because they don't trust politicians on fiscal policy.  How could they after the Reagan years?  America's national debt in 1989 (the year he left) was three times that of 1981 (when he entered).

Also, it tends to be supported in countries where inflation has historically been a problem -- usually in Latin America, where governments, instead of slashing rates, would simply run huge deficits.  (The problem is that, once they started focusing on monetary policy, they simply printed money to pay off the debt, which not only created hyper-inflation, but really pissed off lenders.)

Be nice to America. Or we'll bring democracy to your country.

by Drew J Jones (pedobear@pennstatefootball.com) on Thu Dec 1st, 2005 at 10:40:40 AM EST
[ Parent ]
Ok, we have one central bank setting the interest rates for the whole Eurozone, but 12 countries with the ability to issue debt in Euros at will. Who decides how much money is printed, and when? And is the "stabilization pact" all about preventing one country's reckless fiscal policy from hurting the other 11?

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman
by Carrie (migeru at eurotrib dot com) on Thu Dec 1st, 2005 at 10:53:34 AM EST
[ Parent ]
This is why countries aren't supposed to run deficits of more than 3% for several years running.  

According to the Econmist's figures the Euro, broad or M3, has been increasing by ~10%/year.  Not being privy to the meetings I don't know why they have decided to do this but the recent buget deficits of France and Germany (and Italy!) requiring borrowing coupled with the devaluation - through inflation - of the US dollar are, I'm guessing here, primary reasons.

She believed in nothing; only her skepticism kept her from being an atheist. -- Jean-Paul Sartre

by ATinNM on Thu Dec 1st, 2005 at 11:52:38 AM EST
[ Parent ]
I keep asking myself that because people keep mentioning it... From Wikipedia:

Scope of Money Supply"

Broader measures include money held as a store of value. Different measures of money have different technical definitions. The most common measures are named M0, M1, M2, and M3 (from narrow to broadly defined). In the United States they are as follows, as defined by the Federal Reserve:
  • M0: The total of all coins 'minted' and paper 'printed' cash in circulation. (i.e. currency)
  • M1: M0 + the amount in demand accounts (also called "checking account" or "current account")
  • M2: M1 + other various savings account types, money market accounts, and certificate of deposit accounts (CDs) of under $100,000.
  • M3: M2 + all other CDs, deposits of eurodollars and repurchase agreements. As of March 23, 2006 information regarding the M3 will no longer be published by the Board of Governors of the Federal Reserve System, in contrast to the other three reports of the United States money supply, provided in detail .
Can anyone expect the (in)significance of the Fed discontinuing the M3 statistical series? Are they trying to hide something?

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman
by Carrie (migeru at eurotrib dot com) on Thu Dec 1st, 2005 at 12:05:43 PM EST
[ Parent ]
Doubtful.  The Fed is not likely to try and hide anything.  (Why would it?  The people on the board are all millionaires who couldn't care less about the public's opinion.  I don't see any real political motivation -- and that's what, I think, would be required -- to hide something.)  The Fed has one job:  Keep prices reasonably stable.  Period.  The stimulus/dampening of economic activity comes second.

Be nice to America. Or we'll bring democracy to your country.
by Drew J Jones (pedobear@pennstatefootball.com) on Thu Dec 1st, 2005 at 01:35:36 PM EST
[ Parent ]
Can anyone expect
Er... can anybody explain?

I can definitely not type this week.

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman

by Carrie (migeru at eurotrib dot com) on Thu Dec 1st, 2005 at 01:50:14 PM EST
[ Parent ]
Per definition above.  The qualitative definition is: the total, estimated, amount of a currency in existence.

Or the road running from Sunbury to Chandlers Ford.  

Take your pick.  ;-)

Don't rightly know the reason(s) the Fed isn't going to publish the M3 number anymore.  I'll scout around tonight and see what I can find.

She believed in nothing; only her skepticism kept her from being an atheist. -- Jean-Paul Sartre

by ATinNM on Thu Dec 1st, 2005 at 05:44:55 PM EST
[ Parent ]
So which of the four M's is the relevant one for inflation? I would guess M1, since M2 and M3 is money more or less frozen into investment and not immediately available for consumption.

By the way, according to the Wikipedia article, as of July 28, 2005, the figures were:

  • M0: $0.7 trillion (  7%)
  • M1: $1.4 trillion ( 14%)
  • M2: $6.5 trillion ( 67%)
  • M3: $9.7 trillion (100%)
For comparison, the 2005 GDP estimate is $12.6 trillion.

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman
by Carrie (migeru at eurotrib dot com) on Thu Dec 1st, 2005 at 05:55:35 PM EST
[ Parent ]
What's your definition of inflation?

Rise of consumer prices as measured by CPI?  Net increase in money supply?  Gross increase in money supply?  Excess increase in money supply over some criteria?  (And what does "Excess" mean?)

Each of these have their uses for reasons too long to get into here.  

The usual figure used to estimate inflation in quantification analysis is the Consumer Price Index more to keep things somewhat simple than the superiority of the (political massaged) figure.  As I shall attempt to show.  

To really get at inflation you need to take the total rise of M3 minus the amount of increase used for long and medium term investment (> 1 year) as adjusted by the rise (if any) in the cost of goods and services caused by that increase in M3, the overall price affect by the increase, minus the amount of loss actually realized during the time period in any investment, the velocity of the money (how fast the currency changes hands)  ... and I'm sure I've forgotten something(s).  This indicates why M3 is so important as it is the basis from which any further calculation must start.

I like to use the M3 figure as a stand-in for how much the plutocrats have had to play with, as they are first in line to get the additional money, and the yield on the 10 year bond for the market consensus prediction of inflation over the time to maturity (1 month, 3 years, 7.5 years ... whatever.)  

The difference between these two figures should, roughly, agree with GDP if the money supply is 'stable.'  Over the last 4 years they have not agreed intimating Greenspan has been pumping more money into the economy than is actually required causing the excess to flow into the housing and other bubbles.

MHO.  YMMV.


She believed in nothing; only her skepticism kept her from being an atheist. -- Jean-Paul Sartre

by ATinNM on Thu Dec 1st, 2005 at 06:35:37 PM EST
[ Parent ]
The amount of money printed is decided by the ECB, but it's affected by the fiscal policies of the member states who use the euro.

And is the "stabilization pact" all about preventing one country's reckless fiscal policy from hurting the other 11?

I don't know what the motivation was behind the "stabilization pact," but that would certainly make sense.

The EU becomes a bit messy here.  State governments in the US have, I believe, the ability to issue debt in dollars, though most have balanced-budget amendments written into their constitutions.  However, their borrowing is backed by the federal government with the "Full Faith & Credit" clause.  Who is backing the 12 debt-issuing countries of the EU?

One of you can probably fill me in on the law.

Be nice to America. Or we'll bring democracy to your country.

by Drew J Jones (pedobear@pennstatefootball.com) on Thu Dec 1st, 2005 at 01:41:51 PM EST
[ Parent ]
The "Stabilization Pact" was the only way to get the Germans to give up the Deutche Mark for the Euro.

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman
by Carrie (migeru at eurotrib dot com) on Thu Dec 1st, 2005 at 01:45:34 PM EST
[ Parent ]
How ironic that Germany is running these deficits, then.

Be nice to America. Or we'll bring democracy to your country.
by Drew J Jones (pedobear@pennstatefootball.com) on Thu Dec 1st, 2005 at 05:24:27 PM EST
[ Parent ]
Personally I don't see the irony, it just pisses me off.

On the other hand, the Mediterranean countries fiddled with their accounts in order to meet the "Maastricht convergence criteria" needed to join the Euro.

I guess nobody's perfect.

Italy's being royally screwed by their inability to apply their traditional fiscal policy, which involved large devaluations of the Lira at regular intervals. They can't touch the interest rates, they can't borrow above 3% and they can't inflate themselves out of trouble. I guess they'll have to learn to run their economy like everyone else.

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman

by Carrie (migeru at eurotrib dot com) on Thu Dec 1st, 2005 at 05:44:55 PM EST
[ Parent ]
The irony is that Germany pushed for the stabilization pact and then broke the deficit rule.

Be nice to America. Or we'll bring democracy to your country.
by Drew J Jones (pedobear@pennstatefootball.com) on Thu Dec 1st, 2005 at 11:08:36 PM EST
[ Parent ]
Also, read Keynes's chapters on Interest in The General Theory....

Be nice to America. Or we'll bring democracy to your country.
by Drew J Jones (pedobear@pennstatefootball.com) on Thu Dec 1st, 2005 at 10:42:15 AM EST
[ Parent ]
Could you point me to a Keynesian analysis of the 70's stagflation?

I'm not trying to pick a fight here.  I really am interested.


She believed in nothing; only her skepticism kept her from being an atheist. -- Jean-Paul Sartre

by ATinNM on Thu Dec 1st, 2005 at 11:45:26 PM EST
[ Parent ]
Big mistake, in my opinion.

First of all, monetary conditions in Europe are not particularly accomodative right now:

Monetary conditions have been getting tighter over the last four years, not looser. Which coincides with a period of slower growth and rising unemployment.

Second, accelerating inflation is not a problem for Europe right now:

Inflation in the EU15 is now running under 2%, and close to 0% in countries such as Germany.

Third, despite what the FT says, Europe is probably not at "full employment," even by the perverse standards that terms 8% unemployment as "full employment":

In such an environment, it may be that an unemployment rate above the natural rate may lead to low rather than declining inflation, so Europe's current stable inflation rate does not mean that the European unemployment rate is at the natural rate.

Last, those "Taylor Rule" estimates are entirely dependent on choosing the right inflation target. Choosing an excessively low target may make your monetary policy look accomodative even as it is indeed choking off demand:

If it is true that inflation has been fluctuating around 2% in the past two years, justifying the stability of ECB rates with respect to its target, it is also true that precisely the decision of the ECB to set the target rate at 2% may be seen as the "original sin" of monetary policy in the Euro zone. In fact, the period of low inflation that preceded the inception of the single currency has created an historical anchor that in view of the following events proved to be too low, and hence induced a restrictive bias in monetary policy. I argued elsewhere2 that a correct target rate for inflation should be 2.5% or 3%.

Is the problem with the European economy excessive inflation and "overheating"? Of course not, the very question is absurd.

The problem is slow growth and high unemployment. Which usually calls for rate cuts, not increases.

by TGeraghty on Fri Dec 2nd, 2005 at 01:39:42 AM EST
The official announcement is here.

and here 'tis:

Discontinuance of M3

On March 23, 2006, the Board of Governors of the Federal Reserve System will cease publication of the M3 monetary aggregate. The Board will also cease publishing the following components: large-denomination time deposits, repurchase agreements (RPs), and Eurodollars. The Board will continue to publish institutional money market mutual funds as a memorandum item in this release.

Measures of large-denomination time deposits will continue to be published by the Board in the Flow of Funds Accounts (Z.1 release) on a quarterly basis and in the H.8 release on a weekly basis (for commercial banks).

And that is it.  

Apparently the FED doesn't think policy makers are using the number for anything and wants to save the couple of thousand bucks a year it costs to produce and distribute the figure.

She believed in nothing; only her skepticism kept her from being an atheist. -- Jean-Paul Sartre

by ATinNM on Fri Dec 2nd, 2005 at 01:53:20 AM EST


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