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96 Deleveraging, What Deleveraging
Afternoon general discussion
Part of the discussion concerned sequencing. Alexander Swoboda described
a caricature of the usual sequencing discussion as prevention, mitigation and
resolution. The experience is that we have not prevented the crisis very well,
that we mitigated it somewhat and that we have not resolved the problem yet.
Claudio Borio has observed that it is never a good time to solve problems or to
reform. When you are on the upswing of the credit or leveraging cycle, you don’t
want to take the ‘punch bowl’’ away because you might be accused of having
aborted the recovery. And when you are in the down phase of the business cycle,
it is really not the time for austerity, to put an additional burden on the banks,
and so on. Then we find ourselves in a situation where we are damned if we do
and damned if we don’t. Interest rates have been low and that was necessary for
one goal, but we don’t dare raise them to prevent the next bubble or crisis and
perhaps the next crisis will come. A useful reminder is provided in the summary
of the paper ‘’ Resolving Debt Overhang: Political Constraints in the Aftermath of
Financial Crises” by Mian et al. (2014), which ends: ‘This paper advances the idea
that countries become more politically polarised and fractionalised following
financial crises reducing the likelihood of major financial reforms precisely when
they might have especially large benefits.”
Laurence Boone argued that the Eurozone cannot have the same sequencing
as the US because it is not a federation. Indeed, in 2010-11 the markets and
policymakers were talking about a Eurozone breakup. The UK regulator was
asking banks every month about their contingency plans if a breakup were to
happen. The Eurozone could have had the same sequencing as the US if it had
decided to move to a fiscal union and the debt of the region was serviced by the
entire Eurozone GDP. Instead, the debt of Italy is being serviced by the GDP of
Italy, and so on. However, once the Eurozone decided to stick with the ‘limited
liability partnership’ that we have today, the sequencing of policies could not
proceed in a similar manner to that of the US.
According to José Luis Malo de Molina, there is nothing to object to regarding
the sequencing proposed in the report, but in practice very important problems
arise. The first problem is how to implement a strategy of fiscal consolidation
and austerity until the end of the process. Policymakers need from the beginning
to have a credible strategy of medium-term fiscal consolidation. We have seen
what has happened in Greece, Portugal, Spain and Ireland, where problems of
credibility were at the core of the problem from the beginning. Second, in order
to sort out the banking system, policymakers need a lot of public money. To
do it in a credible way, government balance sheets need to be healthy. If not, it
is very hard to implement the sequencing suggested by the report, as it means
leaving austerity until the end of the process. Finally, when comparing the size
and the timing of the ECB and Fed interventions, the most important factor is
the channel. The channels used by the Fed and ECB are different because the
markets in the US are different from those in Europe. The kinds of assets that can
be purchased by the ECB are different from the ones that can be purchased by the
Fed. The guidance channel, an attempt to affect the final prices, is also different.
Laurence Boone reinforced this analysis, asking how the ECB can buy assets