Ryan Avent: "Mr Cowen's posts, and many other like them by other authors, sometimes look like elaborate efforts to avoid concluding that German inflation-phobia, while totally understandable and rational, looks like a grave moral error in the current econ
Ryan Avent watches Karl Smith remind Tyler Cowen that people respond to market prices, and piles on himself:
The euro crisis: Der Elefant im Raum: TYLER COWEN writes on the euro-zone economy:
Would the new helicopter drop money be kept in periphery banks and lent out to stimulate business investment? Or does the new money flee say Portugal because Portuguese banks are not safe enough, Portuguese loans are not lucrative and safe enough, and Portuguese mattresses are too cumbersome? The former scenario implies that monetary policy should be potent. The latter scenario implies that the helicopter drop will be for naught and the fiscal policy multiplier also will be low, on the upside at the very least (fiscal cuts still might cause a lot of damage on the downside). I call this the liquidity leak, rather than the liquidity trap.
Karl Smith gives the correct response:
What Tyler calls a liquidity leak, I call markets at work. The ECB provides enough stimulus to get all of the Eurozone going but it all leaks to Germany. Fine. The German market heats up. German wages and rents rise. Retired German doctors start considering the virtues of a flat in Lisbon overlooking the harbor. German consultancies hold seminars on “How to make your Mediterranean town competitive in the new German Outsourcing Model.” This is the way things are supposed to work. The idea that a more competitive and efficient Germany should not command higher wages and rents is bizarre; and is only called inflation because the Eurozone, in its heart-of-hearts, doesn’t actually believe its one monetary union where the richer parts are distinguished principally by the fact that they have more money.
Mr Cowen disputes that this solves anything, but his reply reveals why monetary expansion in the euro area is so critical. Mr Cowen first argues that:
Portugal and Germany are not directly competing in so many export markets to a high degree. So raising German wages and prices helps Portugal only somewhat. Furthermore, the marginal propensity of Germans to spend, or the marginal propensity of German banks to lend, is not mainly directed toward the periphery.
As far as I know, Mr Cowen is simply speculating about the marginal propensities here. But the entire idea behind the leak, and the value of differential inflation, is that it will create export competition or import substitution where there wasn't any before. There are lots of stores I don't shop in but would if their prices were cheaper. Second:
[T]his mechanism solves (at best) only one of the core problems of the eurozone, namely incorrect relative prices between Portugal and Germany. It helps less with the “Portuguese nominal wages are too high” problem, the “Portuguese banks are not sound” problem, and the “Portugal badly needs structural reform” problem, among other difficulties.
That monetary policy, like penicillin, is not a panacea is no reason at all not to apply monetary expansion, or penicillin, when it is called for. And I am surprised at this point that we're still pretending as though there is no interaction between demand-side issues, financial weakness, and structural reform. The past few years have reinforced again and again that demand shortfalls significantly exacerbate shakiness in the financial system and sap political systems of their appetite for reform. Portugal needs a lot of things, in the way that a given patient could probably stand to lose a few pounds and visit a dentist. But if the given patient is dying of infection it seems bizarre to discount away the value of antibiotics. Being alive and unhealthy is much better than being dead.
[O]ne effect of this policy would be that Germans buy up a lot of Portuguese assets. “Not that there is anything wrong with that” I hear you saying and indeed that is right. Still, solving the crisis by selling a lot of the country to the Germans is not exactly a popular policy in a lot of the periphery and we could expect political resistance from that side as well.
The Greeks understandably don't want to be forced into selling the Parthenon or their islands to the Germans. But they were more than happy to sell their assets to Germans during the boom and would no doubt be glad to do so now if it meant falling unemployment.
But this, right here, is the heart of Mr Cowen's post:
Imagine telling Americans that they must endure a good deal of inflation to help solve some aggregate demand problems in Ecuador and El Salvador.
Americans would scratch their heads and wonder what the hell Mr Cowen was talking about. If either Ecuador or El Salvador had a demand-shortfall problem they could just devalue relative to the dollar. Mr Cowen's follow up points that Ecuador and El Salvador don't actually seem to be suffering from demand issues is a curious non-sequitur. The bottom line is that America has not made a deep political and economic union with Ecuador or El Salvador the central focus of its economic and diplomatic policy. The situations could not be more different.
And yet, if Americans could alleviate substantial suffering in Ecuador and El Salvador simply by tolerating a bit more inflation for a few years, and they chose not to, that would be a pretty significant moral error on America's part.
Mr Cowen's posts, and many other like them by other authors, sometimes look like elaborate efforts to avoid concluding that German inflation-phobia, while totally understandable and rational, looks like a grave moral error in the current economic environment. Obviously the periphery has huge problems that will not go away given more monetary expansion and higher inflation in Germany, and obviously it is not Germany's fault that they have made x, y, and z good economic decisions while the periphery has taken q, r, and s bad ones. For all that, it is still the case that higher inflation in Germany would alleviate substantial suffering around the periphery at fairly minimal cost to Germans (for their suffering, as we've seen, they get more holidays in Portugal and a nice Mediterranean real estate portfolio). Many Germans might prefer not to accept that trade-off, such as it is. Voters of any other nationality might well make the same choice if put in that situation. But that doesn't make it the right choice. Not by a long shot.