Jean-Claude Trichet's "apology" and responsibilities

Yesterday, Jean-Claude Trichet apologized at a European Parliament hearing concerning the role of the “troika” of international lenders (which managed bailouts in Cyprus, Greece, etc), with his response surprising many, as he blamed Member-State governments for the situation the EU is currently facing and basically washing his hands off the subject.

What caused some to wonder about Trichet's behaviour was that he did not admit any mistakes made by the Troika (and in essence the ECB, even when the IMF admitted to have under-estimated the GDP projections) and showed no remorse whatsoever. A prevalent idea is that Trichet did not do much during his stint at the ECB. Yet, he claims that without his actions, Mario Draghi's "whatever it takes" speech wouldn't have mattered much. 

To be fair, he deserves some credit. Trichet was head of the ECB during 2003-2011 and with the crisis beginning to show its teeth in 2009, the following table shows monetary policy actions since 2009 (even though the policy rate fell by more than 125 basis points in 2008 as a response to the sub-prime lending crisis).

As the reader may observe, the ECB's deposit facility rate fell dramatically in 2009, after new evidence on Greece showed that the country was sitting on a huge pile of debt; in fact both the main refinancing operations and the marginal lending facility rate were reduced during the year. This was actually more than most observers believed the ECB would do at the time. The rate remained unchanged during 2010 while, in an irrational change of mind, it was raised during 2011. As you may remember, the Decision to appoint Draghi was taken in June 2011, while the official inauguration date was in November 2011. Now, the only reason I am bothering you with the dates is that both the rate hikes in 2011 occurred while Trichet was heading the ECB. In fact, just 8 days after Draghi took over, the ECB rate was reduced by 25 basis points. 

In addition, have a look at the European Interbank Overnight (EONIA) Rate in 2010 and 2011: as it appears, the interbank cost of lending rose significantly in those two years (and only began to its fall after November 2011), at a time (after the first Greek PSI in late 2010 and just before the second PSI in Autumn 2011) when confidence about the banking sector had reached its nadir, with the whole situation forcing huge losses on periphery banks. During the same time, daily open market operations were reduced by approximately 38% from 775,559 to 483,141, while liquidity based on the Covered bond purchase programme more than doubled from 2010 to November 2011 (albeit in absolute numbers it was much less than the reduction of open market operations).

Source: http://www.global-rates.com/interest-rates/eonia/eonia.aspx

Yet, Trichet (or the ECB if you prefer) did something else in order to assist the then ailing European economy: bought large amounts of Irish and Greek government bonds as early as 2010, a policy which well continued in 2011. Had there not been the ECB buying bonds the crisis would have evolved much faster and with greater severity, as it has been a combination of both banking and sovereign trouble. Yet for some countries (Spain, Cyprus, Ireland), the former sector was the one which caused the latter to face problems, while for others (Italy, Portugal, Greece) it was mainly the latter which imposed its burden to the former. 

The ECB's reaction was one to "save the sovereigns" and somehow ignore the banks. This was justifiable at some point: the last three countries, of which Greece got the most publicity during the Trichet presidency, would have gone down spectacularly had the ECB not intervened. As for Ireland, the government was "forced" to guarantee the banks to avoid total collapse, thus forcing the ECB to "guarantee" the state. It goes beyond logic to suggest that the ECB did nothing for Ireland (or other countries in the EZ) during the crisis; yet it is equally illogical to suggest that the ECB did everything it could.

Summing up, the idea that Trichet did nothing, as well as the idea that his actions were what the Eurozone needed at the time are both nonsensical. Trichet should have lived up to his role as the ECB President and stand up against the PSI (if he was really against it). In addition, blaming others for their mistakes and not acknowledging that you could have done much more is not a sign of strength. Yet, the same holds for the MEP's: they are free to judge anyone for the outcome of their actions, but they should not forget that they are also liable for notorious inaction during the crisis. We all know that it's easy to judge in retrospect but it appears to be much easier to do nothing and then judge others about their actions.

P.S. A note to those who suggested that the PSI came back with a vengeance in Cyprus: the "bail-in" is much different from the PSI. In the latter the bank loses capital by experiencing losses in invested funds (in this case government bonds) while in the former it gains capital by effectively seizing deposits. And yes, the latter is better.

Austerity and Wages: The Real Data

From what we can see very few have actually bothered to see the effects of austerity measures in the lives of people. Thus, after some (very light) data mining I present you the effects that these austerity measures had on the Greek and Irish economies. Unfortunately, we do not have the opportunity to study other nations for the time being, as data only go as back as June 2012. Yet I will contrast the results for Greece with those of Germany during the 2006-2012 period.

Note: All results are inflation-adjusted (i.e. real) and account for gross wages (y-axis represents aggregate wages in the economy)

Real Wages in Greece

In the graph above, the two vertical lines represent the first two austerity packages the country passed, one in May 2010 and the other in February 2012. According to the data, the real value of the country's wages began to fall just before the 1st memorandum and is continuing its downwards slop up to day. In contrast, have a look at real wages in Germany:

Real Wages in Germany

Here, real wages only took a slight fall during the late 2008 crisis, but have resumed their upward trend in 2010, rising substantially over the past couple of years. If the Greek data are not enough let's have a look at the next graph:

Real Wages in Ireland

As anyone can see, wages in Ireland have also taken a tumble over the past 3 years. The straight line represents the 2009 budget which was aimed at salvaging the Irish banks and reduced government spending so that the debt burden assumed would be sustainable. The point of contrasting the aforementioned two countries with Germany is not to blame the latter. It is merely to point that Germany is here a case where policies have worked well while Greece and Ireland the cases where terrible policies did not have the results expected by policymakers. Worse of all, the result expected had no relationship with reality whatsoever. 

As economists, we expect that once the public's purchasing power is lowered then prices will fall as a result of less demand. This is actually what is being taught in Economics 101 in every university in the world. (see graph below)

Simplistic economics: Lower demand (Demand 2) means lower price (P2).

What economists in the IMF and the EU have failed to see is that prices do not change so fast. In fact, they may not change at all during the short-term (depending on how you measure short-term of course. Here, I assume is it as less than 2 years). In fact, an article in a Greek newspaper stated that prices in the economy just showed a declined. The date: February 6th, 2013. One could post data on inflation in Greece but these would be redundant. Real wages represent the current state of the economy much better and with greater insight on the public's purchasing power.

Since people do not behave as economists believe they do (and no economist has ever thought about changing the models or defining "rationality" in a different way) it is obvious that real-life effects will differ significantly from what is expected in theory. Greece and Ireland appear to have been nothing more than economic experiments; so that economists can learn that the world does not function the way they had thought. Unfortunately, it takes more than just one nation for economists to understand and admit mea culpa. The same situation is about to happen in Cyprus and has already happened in Portugal, Italy and Spain.

Did the authorities have an alternative? Yes: induce less rapid austerity measures, so that the reduction in government expenses would not cause such extreme responses, making a more gradual move from over-spending to under-spending. Now, let's assume that they did not know about this and they had to make a mistake to learn about it; now that they have learned, will they do anything fix this situation?

Ireland and False Promises

Anyone who has been watching the news over the last 4 years will definitely remember the case of Ireland. A very strong economy, booming at the time, faced significant constraints in 2008 due to the large exposure of banking institutions to sub-prime loans abroad, in addition to a housing bubble burst in the country. Thus, in order for the Irish to be able to save their banks, a joint IMF and EU loan of about €85 billion was granted to the nation. The terms were the usual: austerity and even more austerity.

The result: as of 2012, only 1% growth in GNP instead of the promised 4% in a 2009 forecast. Government debt is 120% instead of the forecasted 79%, investment fell about 4% instead of rising by 9% and the only reason unemployment has fallen is because 350,000 people have fled the country. (I am really beginning to wonder what the people behind the forecast were thinking when they calculated the numbers).

Protests against austerity measures. Source: William Murphy/Flickr under CC 2.0

The case of Ireland resembles the cases of both Spain and Cyprus: a housing bubble bursting and bank bailouts which forced the nation to assume extreme levels of debt. The result will also be the same: austerity measures, destroying any potential for growth over the next years, people facing extreme difficulties in their everyday lives as even though wages and pensions are falling prices do not follow the same route, and the "upper" class not having to worry about any of these.

Bank officials are still earning six-digit incomes every year, and politicians have seldom seen their wages diminishing over this period. According to the Irish Times, politicians most people have never heard of, are entitled of a €2.2 million pension. Had this occurred at any other period of time, we would have just thought it was because the economy is booming; at the present time it appears as a ridicule to the efforts of the innocent people bearing the cost of the banks' errors.

We are moving towards a pure capitalist society where money comes first and everything else second. At least that is how our leaders behave. We have to pay for the mistakes others have done. I heard a saying once that an insane person throwing a rock in a well will need 40 sane people to get it out. This is what is essentially happening in Europe now. We are paying for wrong decisions, poor judgement and false ideologies. Politicians cannot see the way we do because their incentives are different. In a discussion with Constantin Gurdgiev he stated that politicians face the same incentives as bankers; he was right. It does not mean anything to them whether 99% of the people are paying for the sins of the other 1%. Simply because they will get their money and benefits anyway. And if they manage to do something good for the country as well then even better; if they do not who cares?

The distinction between politicians and those who elect them is growing larger and larger. This inevitably leads to the former believing that they are masters of the game and the latter hoping that the game will someday change. The only way for this to change is to have the politicians more liable for their actions than they are now. I have already proposed a scheme for this, with the goal of aligning the politicians' and policymakers' incentives to those of the people who elect them. The issue is who would be brave enough to apply it?

We all know that having to suffer for the banks' mishaps is unfair. Yet, the banks should not have allowed us to spend so much in the first place. It all goes back to a vicious cycle of banking policies, supervision and the notion that the state will always be there as the lender of last resort. New banking supervision rules should be made so that no systemic collapse can occur when a banking institution fails. Given the size of the banks in the modern day a simple solution would be to split them into separate institutions. Yet, what politician or policymaker would be so determined to do so given that their incentives tell them a different story?

Too much benefits?

After viewing Eurostat's "Government Finance Statistics" publication for 1/2012 in which all data concerning income, expenditure, debt, deficit, and much more were visible, what amazed me was the size of social benefits paid by each country in the EU. Take a look at the following:

What is obvious from the above statistics is that all crisis-ridden nations have seen their social benefits rise over the past 15 years. Greece, Portugal and Cyprus are the top three in increases with 8.4%, 9.5% and 7% respectively. On the other hand, Germany and Finland have reduced the social benefits they pay by 1.5% and 2.6% respectively. It is noteworthy that the nations whose social benefits rose substantially over the last 15 years were the ones which in 1996 had the lowest percentages (Cyprus: 8.3%, Ireland: 12.5%, Portugal: 12.6%, Greece: 13.5%) This phenomenon is rather strange as citizens of most of the aforementioned countries will indicate that they were better off in 1996 than 2012. As politicians and policymakers increases social benefits