A couple of Market Monetarists seem to be suggesting that the ECB should forget about standing as Lender of Last Resort and instead simply focus on a Nominal GDP level target of perhaps 4% or so.

There is a part of me that is twisted enough to want them to do this just to see what would happen.

Off the cuff I can see a couple of possibilities

Scenario One: The market believes the target and concludes that this means the periphery countries will be able to self-finance. Spreads collapse, the money supply expands rapidly and Europe emerges from its current double-dip in six to nine months.

Scenario Two: The market believes the target, but concludes that the result will be extremely rapid near term real growth and inflation in Germany, with matching stagnation in the periphery. Spreads on sovereign debt continue to expand, there is wide spread default and we enter Post-Apocalyptic Nominalism.

Scenario Three: The market doesn’t believe the target, spreads continue to rise, there is default and we enter Post-Apocalyptic Nominalism.


Now what does this Post-Apocalyptic world of NGDP targeting look like? Its not immediately clear because we could have complete collapse of the banking system. At that point we have to ask how the ECB is going to go about injecting money into the economy.

One way, however, would be via bond purchases. This is interesting because it we have a world were the supply of money is rapidly collapsing as the banking system descends into oblivion. Real output is collapsing and deflation is setting in.

Yet, in order to hit its target the ECB has to be devoted to increasing the money supply. Presumably this then means very aggressive bond buying from any institution that can issue bonds that the ECB determines to have low default risk.

That opens the door for the ECB to wind up funding bond purchases at highly negative nominal rates. This would allow a small set of player to build up massive economic empires in the wreckage, possibly large enough to draw Europe out of depression but into a world in which European wealth was concentrated into very few hands.

Now why do I see highly negative nominal rates. Isn’t there a Zero Lower Bound on nominal rates.

There is a ZLB if you have a place to safely stockpile cash or reserves. However, you don’t because the banking system has been annihilated.  There is also a ZLB – or something close – if you have a competitive market for borrowers. However, you don’t because in post-Apocalyptic Europe the number of institutions eligible to have their bonds purchased would be tiny.

You also have a ZLB if lenders are attempting maximize profits but the lender is the ECB and it is committed to expanding the money supply in order to hit its NGDP target.

So, you have removed the constraints that create the ZLB opening the door for negative nominal rates for a few key players who will then become massive wealthy.

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