central bank independence

Latvia Is Endorsed to Adopt the Euro

FRANKFURT — The small Baltic nation of Latvia received official endorsement for membership in the euro currency union Wednesday, in a move that European leaders clearly hoped would demonstrate the endurance of the euro zone despite its dismal economic performance and damaged reputation.

“Latvia’s desire to adopt the euro is a sign of confidence in our common currency and further evidence that those who predicted the disintegration of the euro area were wrong,” Olli Rehn, the European Union’s commissioner for economic and monetary affairs, said in a statement.

Both the European Commission, the European Union’s main policy-making body, and the European Central Bank said that Latvia had met the requirements for membership, which include limits on inflation and government debt. Latvia also had to demonstrate that its laws on issues like central bank independence are in line with European Union standards.

Latvia’s application still requires review by the European Parliament and endorsement by European Union political leaders, a process that is likely to result in formal approval in July.

Latvia would join on Jan. 1, becoming the 18th European Union country to adopt the euro.

The country, with 2.2. million people and economic output last year worth about 20 billion euros, is often held up as a model for advocates of austerity because the country responded to a severe banking crisis in 2008 by slashing government spending.

Economic output plunged, unemployment soared and wages fell, but the Latvian economy gradually recovered. The country’s economy grew 1.2 percent in the first quarter of 2013 compared with the previous quarter, second only to neighboring Lithuania among European Union countries.

“Latvia’s experience shows that a country can successfully overcome macroeconomic imbalances, however severe, and emerge stronger,” Mr. Rehn said.

However, opinion polls indicate that most Latvians are reluctant to join the euro, even though they have a powerful political incentive to do so. Like Estonia, another Baltic nation, which was the most recent country to join the euro in 2011, Latvia is anxious to tie itself to Europe and distance itself from its former Russian masters.

The Latvian government did not hold a voter referendum on euro membership. In many ways, the country is already a de facto member. The country has kept its currency, the lat, closely tied to the euro. And Latvian bank loans are commonly denominated in euros.

In its report, the European Commission said it had concluded that Latvia “has achieved a high degree of sustainable economic convergence with the euro area.”

The European Central Bank was also generally positive about Latvia, but expressed some concerns about the country’s readiness.

About half the deposits in Latvian banks come from outside the country, primarily Russia. That raises the risk of a sudden exodus of money in the event of a crisis. Earlier this year, Cyprus, another tiny euro zone member, was forced to limit withdrawals to prevent a bank run by Russian depositors.

But Latvia is considered less vulnerable to a Russian deposit flight than Cyprus because most of the money is linked to genuine business ties. Cyprus was regarded as a place where Russians parked their money to avoid taxes or because of fears that Russian authorities might one day seize assets.

The European Central Bank also expressed some concern whether Latvia could continue to meet the inflation targets required of euro members. While inflation has been well below 2 percent lately, Latvia has experienced huge swings in prices during the last decade, the central bank said, ranging from deflation to annual inflation of more than 15 percent.

The governor of the Latvian central bank will automatically join the European Central Bank’s governing council and have a vote in decisions on interest rates and other monetary policy issues. It is unclear who that person will be, since the term of the current governor, Ilmars Rimsevics, expires at the end of this year.

Historically, though, Latvia has stuck to the kind of conservative policies favored by Germany, Finland and other northern European countries. Government debt last year equaled about 41 percent of gross domestic product, well within limits set by treaty and much lower than Western European countries like France or Italy.

Still, recent experience with countries like Greece and Ireland has shown that nations can have trouble maintaining fiscal and economic discipline after they have joined the euro club.

“The temporary fulfillment of the numerical convergence criteria is, by itself, not a guarantee of smooth membership in the euro area,” the European Central Bank said in its report.

James Kanter reported from Brussels.

Article source: http://www.nytimes.com/2013/06/06/business/global/latvia-is-endorsed-to-adopt-the-euro.html?partner=rss&emc=rss

Political Economy: Valid Worries About the Cost of Easy Money

The Bundesbank, the German central bank, is not crazy. In a world where it is increasingly fashionable to call for central banks to print money, the Bundesbank is one of the last bastions of orthodoxy. Although its stance is extreme, it is a useful antidote to the theory that easy money is a cost-free cure for economic ills.

The bank is hostile to anything that smacks of monetary financing — printing money to finance governments’ deficits. It is worried that central bank independence is getting chipped away as economic weakness drags on in much of the developed world; it thinks that the European Central Bank should not respond to the recent rise in the euro by loosening monetary policy further; it is always concerned about the potential for inflation; and it thinks that spraying cheap money around can allow governments to shirk their responsibilities.

To many people, these attitudes seem old-fashioned. Surely central banks should bend the rules to get the world economy out of its current rut, they say. A few go even further and advocate “overt monetary financing”, as Lord Turner, chairman of the British Financial Services Authority, did in a seminal speech earlier this month.

Overt monetary financing involves governments’ deliberately running fiscal deficits and openly funding them by borrowing from central banks.

Mr. Turner made it clear that this was a policy that should be reserved for the most intractable deflationary recessions, the ones in which monetary policy cannot work (because businesses and households are already so clogged up with debt that they do not want to borrow more) and fiscal policy cannot do the trick either (because governments are over-indebted, too). While he advocated the medicine for Japan, he was wary about giving it to Britain, the euro zone or the United States.

The European Central Bank, it should be added, is not engaging in overt monetary financing. That is forbidden under the Maastricht Treaty, which led to the euro. But it is arguably engaging in the covert variety. This is the source of most of the friction between Mario Draghi, president of the European Central Bank, and Jens Weidmann, the Bundesbank boss — both of whom are based in Frankfurt.

The biggest clash was over Mr. Draghi’s promise last year to buy potentially unlimited amounts of government bonds from peripheral euro zone countries. Mr. Weidmann unsuccessfully opposed the plan. Mr. Draghi was right. If he had not pledged to do “whatever it takes” to save the euro, the single currency might well have collapsed.

That said, all such operations have a cost. Mr. Draghi’s drug may have taken some of the pressure off governments to make their economies more competitive.

Mr. Weidmann and Mr. Draghi clashed again this month over the Irish “bailout” by its central bank. The extremely complex transaction involved the Irish central bank’s receiving €25 billion, or about $33.5 billion, worth of extremely long-term Irish government bonds after IBRC, a nationalized bank, was liquidated. Dublin did not itself have the cash to fill the hole in IBRC’s balance sheet. It has effectively borrowed the money, equivalent to 15 percent of the Irish gross domestic product, cheaply from its central bank.

Mr. Weidmann would have preferred that euro zone governments lend Dublin the money via their bailout fund, the European Stability Mechanism. But other governments were not rushing to provide the cash and Dublin was not eager to use it either, as the interest rate would have been higher than issuing bonds to its central bank.

Although the Irish bailout was a deal between Dublin and its central bank, the European Central Bank could have blocked it. But to do so, two-thirds of its governing council would have had to vote against the operation — and Mr. Weidmann did not have enough support.

Article source: http://www.nytimes.com/2013/02/18/business/global/18iht-dixon18.html?partner=rss&emc=rss

Latvia Is Endorsed to Adopt the Euro

Political Economy: Valid Worries About the Cost of Easy Money

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