Thursday, September 5, 2013

Draghi's Satanic Mandate

“Q: Is the ECB reflecting on the fact that, with high debt and countries coming out weak from recession, a mid-term inflation target is not enough to get out of the crisis; and that there are some economists who suggest that you should also link it to unemployment, as the Federal Reserve System does?

“Draghi: The answer to the question is pretty straightforward. Our mandate talks about price stability and that is our objective: price stability in the medium term.”
--ECB press conference, Sept. 5th, 2013

What is the object of economic policy in general, and of monetary policy in particular? Wouldn’t you say prosperity, or wealth-creation, or an employed workforce, or an economy operating at full potential? Economic policies in modern capitalist countries are supposed to create the conditions for sustainable long-term growth, as opposed to civil war or revolution.

In the US, this is a matter of law. The Full Employment Acts of 1946 and 1978 require the federal government to "promote maximum employment, production, and purchasing power." They provide the Fed with its dual mandate. Given what happened in the US during the ‘thirties, it is understandable that Congress decided to outlaw another depression. And the law has worked. Because of it, the US hasn’t experienced a Second Great Depression.

In the US, there is almost no debate concerning the objects of monetary policy. All economists, whether on the left or right, are supportive of the dual mandate. It is not a topic of debate. How could anyone seriously argue that high unemployment and low growth are desirable?

As we know all too well, Europe decided that, instead of outlawing depression, it would outlaw inflation. Or, to put it less charitably, Europe made a very stupid  policy decision, which is that price stability alone would create the necessary conditions for prosperity. In other words, a full employment mandate is unnecessary because price stability will create full employment.

What is amazing is that even though the ECB has successfully delivered price stability from the day of its founding, for some reason full employment has not resulted. Whatever could be wrong?  What is wrong is that it is impossible to have 4% real growth in a context of 1% nominal growth. Nominal growth sets a ceiling for real growth, since deflation and growth go together like arsenic and good health.

Does Mario Draghi believe that 1% inflation will address the eurozone’s 12% unemployment, or its spiralling government debt ratios, or its banks’ toxic loan portfolios? No, he doesn’t. Let me give you my take on Draghi: he’s the Clint Eastwood character in those 1970s spaghetti westerns. He’s a hired gun. He was hired to deliver price stability, and that’s what he’s delivering. He wasn’t hired to deliver full employment; if you want that you’ll have to amend his contract and pay him extra.

If Draghi were to mention the European depression at a board meeting, the Germans would shout him down. Or perhaps I should say, when Draghi mentions the depression at board meetings, the Germans shout him down. He has mentally compartmentalized his job description, such that he feels no pangs of guilt when he reads about people eating out of trash bins. The sin is not his; it is Europe’s. 

If Draghi had written the ECB charter, it would have included full employment. But he didn’t, so like Eastwood, he just hangs ‘em high.

1 comment:

Jack said...

The desirability of the dual mandate in the U.S. is debatable. One view is that it has resulted in the Fed implementing monetary policies that mask the harmful effects of imprudent fiscal and regulatory policies.

One might argue that, because imprudent fiscal and monetary policies are inevitable, we need the Fed's dual mandate to compensate for them.

The counter-argument is that using the Fed to counter the imprudence of administrations and congresses infantilizes democracy. Their policies should stand on their own, not be propped up by compensatory Fed actions.