The blind leading the bulls
Euromoney Limited, Registered in England & Wales, Company number 15236090
4 Bouverie Street, London, EC4Y 8AX
Copyright © Euromoney Limited 2024
Accessibility | Terms of Use | Privacy Policy | Modern Slavery Statement

The blind leading the bulls

Nomura's Richard Koo explains why - whatever the bulls might like to pretend - the promised cures for the eurozone crisis were never really going to work.

Nomura economist and notorious bear Richard Koo has put out a nice note explaining why the situation in the eurozone doesn’t seem to be improving appreciably. Put simply, European decision-makers have struggled to work out exactly why things are in such a mess, and as such have invested a dispiriting amount of confidence into measures that weren't necessarily going to solve the problems – most notably the LTROs. In his words:

“At first, the vast majority of market participants and policymakers appeared unable to distinguish between a financial crisis, which is a lender issue, and a balance sheet recession, which is a borrower issue. As a result, they overestimated the impact of the LTROs and assumed the ECB’s actions would solve the eurozone’s economic problems.

A senior financial official I spoke with two months ago emphasized that the worst was over and went so far as to say that ‘there is no problem that €1trn cannot solve.’”

Koo neatly explains why the ECB hurling money at the problem while demanding fiscal cutsjust isn’t going to cut it:

“First, the experiences of Japan, the US, and the UK show that monetary accommodation cannot stimulate the real economy when the private sector is seeking to minimize debt in spite of ultra-low interest rates during a balance sheet recession.

Second, fiscal stimulus is the only tool a government has for maintaining aggregate demand when monetary policy has lost its effectiveness. Yet Germany and other countries of the eurozone are actively pursuing fiscal retrenchment.

Third, eurozone members hope that structural reforms will lead to growth, but the examples of Japan and the US show that such policies will not have a positive impact on growth for at least five to ten years.”

All this talk of structural reforms may remind you of Japan under Junichiro Koizumi. How did that work out again?

“The Koizumi administration completely ignored the fact that Japan was in a balance sheet recession and pushed ahead with structural reforms, insisting that there could be no economic recovery without them. But the economy failed to improve, and ultimately the only thing that grew was, in the words of one newspaper, the salaries of directors at the newly privatized Japan Highway Public Corporation.."

Oh, that's right...

At any rate, the really interesting idea here is that a Germany-driven penchant for using a blunt instrument to try and immediately solve the eurozone’s problems, may actually have made the problem worse.

“Some believe that senior German officials understand that rescues will ultimately be needed but feel that unless EU authorities take advantage of the crisis to whip the less competitive periphery nations into shape, they will only face a bigger problem down the road. Hence they are delaying rescue efforts as long as possible while the periphery nations undertake structural reforms.

According to this view, eurozone authorities should take this opportunity to force periphery nations to enhance their future competitiveness by, for example, delaying pension eligibility until the standard German age of 67.

While there is something to be said for this argument, if true, it means that Germany’s insistence on structural reforms has postponed a solution and allowed a problem that was initially limited to the small nation of Greece to develop into a major crisis threatening the entire eurozone.

This is a direct result of the authorities’ attempt to use a single tool (rescue) to resolve two fundamentally separate problems— the debt crisis and the need for structural reforms in periphery nations—that should have been addressed with separate policy responses."

Koo has apparently had some success in convincing people to come around to his way of thinking...

“My recent trip to Europe began with a conference held on the shores of Lake Como in northern Italy. There I had the opportunity to debate these issues with Jürgen Stark, former Bundesbank Vice President and a leader of German economic opinion.”


Many of the seminar participants said afterwards they found my arguments to be more persuasive than those of Dr. Stark.”

“Even if I do say so myself...”

Gift this article