Monday, February 20, 2012

ECB Halts Expansionary Policy

This is deeply, deeply, troubling. Click the headling below to see what I'm talking about.

Now I have covered two different models, IS-LM and market monetarism, both of which strongly suggest the need for monetary expansion in a depressed economy with high unemployment and low inflation. Europe, as everyone nows, still strongly resembles such an economy.

Thats why Jean Claude Trichet's rate hike last year was so wrong headed, and why I attribute much of the blame for the continued crisis in the Eurozone to his tight money policy. But when Trichet was replaced by Mario Draghi in Novemeber of last year, I thought maybe a change in the winds was on the horizon; and for a while, it seemed to be true. Draghi announced that the ECB would begin a program of bond-buying aimed at purchasing at-risk government debt, namely securities issued by Spain, Italy, Ireland, and Greece.

This program served to both increase the nominal money supply (non-inflationary in such an environment, but highy expansionary) and to take some of the pressure off bond markets to load up on all the risky debt, breaking the cycle of self-fullfilling panic. And for a while it seemed to be working.

But today, the program, and implicitly the expansionary policy mindset I'd hoped would be Europe's salvation, has abruptly ended. More on this story as it developes.

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