Maybe Jens Weidmann and Francios Hollande should switch jobs

There seem to be two main positions on how to solve the European crisis. One represented by Bundesbank chief Jens Weidmann and that is that monetary policy should not be eased anymore and fiscal policy needs to be tightened (this is the Calvinist position). The other position is held by the new French president Francios Hollande who wants to spur European growth by easing fiscal policy (this is the keynesian position)

I would claim that both positions are wrong. At the core of the European crisis is rising public debt ratios in Europe. The public debt ration (d) is defined in the following way:

(1) d=D/NGDP

Where D is public debt in euros and NGDP is nominal GDP.

Anybody with rudimentary monetarist insights would inform you that D is determined by the fiscal authorities, while NGDP is determined by monetary policy (remember MV=PY).

If you want to stabilize or reduce d then you have to either decrease D and/or increase NGDP. So what you basically need is fiscal tightening and monetary easing.

Unfortunately Weidmann is basically arguing for reducing NGDP and Hollande is arguing in favour of increasing D. Both positons will lead to an increase in d and hence worsen the crisis. Hence, it would be better if the two gentleman switched jobs  – at least mentally. It would be a lot more productivity if Weidmann argued for monetary easing and Hollande argued for fiscal consolidation. That would do the job and the crisis would come to an end fairly fast.

Between the need for fiscal tightening and the need for increasing NGDP I have no doubt that it is much more important to increase NGDP. The public debt ratios in Europe has not primarily increased because fiscal policy has been eased, but because NGDP has collapsed. In that sense the crisis is not a debt crisis, but a monetary crisis.


Note to the two gentlemen:

To President Hollande (The keynesian): Fiscal policy cannot increase NGDP. Recommend reading: There is no such thing as fiscal policy

To Bundesbank chief Weidmann (The Calvinist): Monetary policy is a panache and it can increase NGDP as much as you like it to be increased. Recommend reading: “Ben Volcker” and the monetary transmission mechanism

Leave a comment


  1. cthorm

     /  May 16, 2012

    Great run of posts lately Lars. Thankfully the censors have lifted the iron curtain here. On the “no such thing as fiscal policy” point at the end, this is so embedded in the way that I think about economics that its causing problems. I’m taking the CFA exam and some of the economics questions flat out disagree with that statement. Frustrating for an allegedly prestigious designation. And how do they justify the statement (I bet you can guess)? My least favorite accounting identity. Oi vey.

  2. Ravi

     /  May 16, 2012

    Lars, hope you caught Draghi’s comments today that the ECB will not keep Greece in the Eurozone “at any cost”. I don’t like the sound of that one bit…

  3. Hey Lars. Good post-I of course differ partly. I like Hollande and wish him good luck. I’ll take either or-monetary or fiscal easing. Whatever’s on tap.

    My guess is that the euro is in trouble. In Greece they’re going to get out of the euro, Angela Merkel and Draghii can pride themelves on “standing their ground” and Italy and Spain go down next in “sympathy with Greece” at some point the euro becomes unworkable.

    If I could ask you a question that’s sort of been on my mind lately with many Market Monetarists is this: if memory serves me you’re in favor of a 3% NGDP target. I know it’s something like that.

    However actual NGDP is already above that. Shouldn’t you then be demanding tigthenting right about now? As you aren’t doesn’t this prove that a 3% NGDP target is no good? I mean we’re above that and we far from have acceptable employment or output rates?

  4. Amarito

     /  May 17, 2012

    Enlighten me please :
    1) Loose fiscal policy increases obviously D but increases also NGDP (the state spends this money)
    2) ECB have of course monetary tools to influence NGDP, at least protect it from deflationary failure, but it has it limits as we see it ?
    3) Is bailing out banks and private institutions different from bailing out states ?
    And a final point, Mr Hollande wants to raise more taxes, it is certainly a form of fiscal tightening.

  5. Amarito

     /  May 18, 2012

    Thank you for your answer. It is a very interesting read, the piece on Gideon Gono too.
    But I’m still not totally convinced : it seems like your main argument against fiscal policy is that monetary problems should be solved by monetary authorities.
    Your argument is purely political by nature, for me it’s just an “institutional illusion”. Even if CBs are independent, they are still “by-products” of the state..They (should) share the same interests, at least in extreme times like nowadays. Printing money to plug monetary holes and induce inflation isn’t imho very different from printing state deficit money.

  6. cthorm

     /  May 18, 2012

    Amarito – the point need not be political. Indeed there is in principle nothing so different about “printing state deficit money” (i.e. fiscal policy) from expansionary monetary policy, both work through inflation. But if you have a central bank that follows any sort of policy rule (and those that don’t are far less effective!) than any expansionary fiscal policy will be counteracted by tighter monetary policy than would otherwise be used. Milton Friedman makes this point here:

    With that said, if you hold the slightest stock in the Hayekian ideas about information and central planning then monetary policy IS substantially more effective than fiscal policy. Money distributed in the hands of many will be more effectively spent than money spent by central planners who can not possibly have sufficient information to spend the money efficiently.

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