For 6 years market monetarists (and occasionally Keynesians like Paul Krugman) have been warning that ECB policy was much too tight. During most of that period the ECB was not at the zero bound, and indeed it occasionally raised interest rates. Now the eurozone has slipped into a Japanese style deflation (i.e. mild deflation, accompanied by near-zero medium term bond yields.) Those German savers who hoped the ECB’s 2011 rate increase would help them out are in for a bitter disappointment. Here’s Paul Krugman:
How is this supposed to end? I like and admire Mario Draghi, and believe that he’s doing his best. But it’s really hard to see how the ECB could gain enough traction here to solve the problem even if it didn’t face internal dissent from the hard-money types.
Krugman supports QE but is pessimistic about its effects. I think that’s right. Rumors of eurozone QE have already depressed the euro, but that modest depreciation is no where near enough to get the job done. QE would work if done “a outrance” (a term used by Keynes in 1930, when he recommended massive QE), but obviously the actual ECB program will fall far short of what’s needed.
It’s clear the ECB (and BOJ) need to switch from IT to price level targeting. The ECB should set a price level target rising along a 1.9% trend line, to avoid any loss of “credibility.” This is what moderate Ben Bernanke recommended for Japan under similar circumstances, this is what New Keynesians like Michael Woodford recommend, and market monetarists also like level targeting. The policy has always been superior to IT, but now in 2015 the advantages of PLT over IT in Europe are so massive that it’s hard to see how anyone could oppose the shift. (Of course NGDPLT would be better still, but would involve a loss of credibility, making it less politically feasible.)
And yet I predict the pundit class will entirely ignore this option, and go on wringing their hands that QE is just not enough, so it’s not the ECB’s fault.
The dark age of macroeconomics continues.