Posted by: Dirk | April 29, 2013

Monetary policy fail: euro edition

Monetary policy, some economists still believe, works like this: if people are saving money, then they bring their money to the bank. This is called savings. Other people want to borrow money, and if the bank has enough money, they can! The interest rate depends on the amount of savings available in the banking system and the demand for loans from entrepreneurs. This story is called loanable funds, and it’s wrong. That’s not how it works. Investments are financed, not saved!

Apparently, many politicians don’t understand the implications of this. German finance minister Wolfgang Schäuble during his visit in Spain has outed himself as a “loanable funder”, according to EL PAIS:

¿Pero está dispuesta Alemania, como piden muchos expertos, a fomentar un aumento de su demanda para así mejorar las exportaciones de los países del sur?, le preguntaron. El “no” fue tajante. “No compartimos la opinión de que si en Alemania impulsáramos un crecimiento más fuerte esto disminuiría los problemas de otros. Hay mucho dinero en circulación, mucho dinero del BCE, y muy poca inversión. Ese es el problema.

So, he was asked, is Germany willing to increase her domestic demand, like many experts call for? A radical “no” was the answer. “We don’t believe in the idea that more growth in Germany means less problems for other countries. There is much money in circulation, much money from the ECB and weak investment. That is the problem.”

Actually, you don’t need money in circulation for banks to give loans. Banks can create money by giving a loan. In return, they give you a deposit in a bank and that is what we call endogenous money. And some people say that the creation of money by banks has fuelled the real estate bubbles in Spain and Ireland. Here is Adair Turner (via positivemoney):

The financial crisis of 2007/08 occurred because we failed to constrain the private financial system’s creation of private credit and money. Resolving this crisis is stuck because this has not been understood by the public, the policy makers or the press. The way our monetary system is set up, money is debt. Since money buys thing, a situation where incomes are falling in some European nations and stagnating in other together with falling government spending and a private sector repaying debt instead of spending money by borrowing leads to one crucial question: if nobody has more money, than how can we expand production?

The regular policy is for the ECB to put the interest rate down, but the ECB has it at 0.75% and is out of room for maneuver. Somebody somewhere has to spend more money. Mr Guindos understands that, and maybe Mr Schäuble understands that, too. Only when the European public gets it we will see the austerity policies for what they really are: transforming society without a mandate towards a society which is more unequal and less solidary. These reforms are in no way helping those countries to grow. Just the opposite: they shrink those economies. Pride and prejudice rule, and perhaps the best quote from the movie is this: “Angry people are not always wise.”


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