---
title: "Wahlroos vs. Rehn: The Monetary Policy Clash | Jussi Ahokas, Antti Ronkainen"
titleOriginal: "Wahlroos v Rehn rahapolitiikka | Jussi Ahokas Antti Ronkainen | #neuvottelija 152"
episodeNumber: "152"
guest: "Jussi Ahokas, Antti Ronkainen"
datePublished: 2022-09-11
duration: "48:20"
youtube: "https://www.youtube.com/watch?v=G-vcDQD-lKY"
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originalLanguage: "fi"
topics: ["finnish_economy_policy","investing_markets"]
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canonical: https://www.neuvottelija.com/podcast/episodes/157-wahlroos-v-rehn-rahapolitiikka-jussi-ahokas-antti-ronkainen/
---
# Wahlroos vs. Rehn: The Monetary Policy Clash | Jussi Ahokas, Antti Ronkainen

## Chapters

- [00:00](https://www.youtube.com/watch?v=G-vcDQD-lKY&t=0s) Rate hikes and monetarism
- [02:50](https://www.youtube.com/watch?v=G-vcDQD-lKY&t=170s) Is there only one inflation rate in the euro area?
- [05:40](https://www.youtube.com/watch?v=G-vcDQD-lKY&t=340s) Supply shocks: the impact of COVID and Ukraine
- [08:30](https://www.youtube.com/watch?v=G-vcDQD-lKY&t=510s) Endogenous money and interest rate policy
- [11:20](https://www.youtube.com/watch?v=G-vcDQD-lKY&t=680s) Recession and the turning interest rate cycle
- [14:10](https://www.youtube.com/watch?v=G-vcDQD-lKY&t=850s) Mandates, credibility and overreaction
- [16:50](https://www.youtube.com/watch?v=G-vcDQD-lKY&t=1010s) The 75-basis-point hike and its criticism
- [19:40](https://www.youtube.com/watch?v=G-vcDQD-lKY&t=1180s) Pressure from the Fed and dollar hegemony
- [22:30](https://www.youtube.com/watch?v=G-vcDQD-lKY&t=1350s) Energy, China and inflation expectations
- [25:20](https://www.youtube.com/watch?v=G-vcDQD-lKY&t=1520s) Liquidity, markets and crisis packages
- [28:10](https://www.youtube.com/watch?v=G-vcDQD-lKY&t=1690s) Central-bank capitalism: a historical arc
- [30:50](https://www.youtube.com/watch?v=G-vcDQD-lKY&t=1850s) The euro as a currency lock and crisis mechanism
- [33:40](https://www.youtube.com/watch?v=G-vcDQD-lKY&t=2020s) The supranational euro and debt ratios
- [36:30](https://www.youtube.com/watch?v=G-vcDQD-lKY&t=2190s) Balance flows and sectoral balance accounting
- [39:20](https://www.youtube.com/watch?v=G-vcDQD-lKY&t=2360s) The purpose of the QE and PEPP programs
- [42:10](https://www.youtube.com/watch?v=G-vcDQD-lKY&t=2530s) Capital-key deviations and overbuying
- [45:00](https://www.youtube.com/watch?v=G-vcDQD-lKY&t=2700s) Legal disputes: PEPP and the courts
- [47:40](https://www.youtube.com/watch?v=G-vcDQD-lKY&t=2860s) Repo collateral and bond market stability

## Summary

Jussi Ahokas and Antti Ronkainen, both doctoral researchers, analyze monetary policy decisions by the ECB and the Fed, inflation, and central-bank capitalism. Björn Wahlroos wrote a guest column in Helsingin Sanomat setting out his monetarist view of how inflation forms; Bank of Finland Governor Olli Rehn responded with a rebuttal addressing Wahlroos's ("Nalle's") claims. The episode explores the evolution of central-bank capitalism, policy alternatives, changes in asset values, inflation, the energy crisis, the impact of Russia and China on Europe's problems, and the euro's political and structural challenges.

## Transcript

*English transcript derived from validated English subtitles ([WebVTT](https://www.neuvottelija.com/podcast/episodes/157-wahlroos-v-rehn-rahapolitiikka-jussi-ahokas-antti-ronkainen/captions.en.vtt) · [SRT](https://www.neuvottelija.com/podcast/episodes/157-wahlroos-v-rehn-rahapolitiikka-jussi-ahokas-antti-ronkainen/captions.en.srt)). Timestamps link to the original video.*

[**00:00**](https://www.youtube.com/watch?v=G-vcDQD-lKY&t=0s) Antti Ronkainen: We're part of the 0.75 crew! So, I was reading Björn Wahlroos's op-ed, and I was honestly a bit puzzled about what this is actually about. It didn't really say much about demand — where that comes from — but supply is the central bank's turf, and that way the central bank can always adjust supply to match demand and bring inflation to the right level. That's pretty monetarist, isn't it. So how can it be that the ECB creates a program for the pandemic where it deviates from the guardrails set by the EU Court of Justice, and then uses that program after the pandemic? I think this is a genuinely interesting question, both legally and politically. And what happened today — 2.3 was that 12-month Euribor — so yeah, Miettinen might get some questions out on the street now that he didn't take out that rate hedge! All right, welcome to the Neuvottelija channel. I have two doctoral researchers as guests today: Antti Ronkainen and Jussi Ahokas.

[**01:05**](https://www.youtube.com/watch?v=G-vcDQD-lKY&t=65s) Hi. Hi. Hey hey. So what are your research topics? Has your research plan progressed far enough that the topic has become clear? It should already be finished, but it's about the justification of central banks' monetary policy and the institutionalization of these new measures, and then how they've affected this paradigm. Very gray. How do you paint your rainbow in all shades of gray? Come on now. I'm — I'm — I'm creating it. What about you, Jussi? Is it as fine? Well yes, I'm researching ideas in macroeconomics and macroeconomic policy and how they change over time and space. So it's a dissertation in the field of political economy and geography, so to speak. We're maybe about halfway through. Is it heading toward technological determinism, toward this 'central bank capitalism' or something like that? Well, actually, Antti and I have done some research collaboration outside our dissertations on that — it's become its own separate project. That's more of a postdoc thing.

[**02:14**](https://www.youtube.com/watch?v=G-vcDQD-lKY&t=134s) Yes. Yes. Great. I'd like to start with this battle of two greats — what should we call it, a clash of titans — so, Nalle Wahlroos, unusually, wrote a guest op-ed from England for Helsingin Sanomat, in which, if I understood correctly, he said, very much like a monetarist, 'don't you in Finland worry so much about regional inflation. In the euro there's only one inflation, and that's the ECB's job.' And if I were to sum it up, that was roughly the main point of the article. And then we got Olli Rehn to say that there are some nuances here — that yes, there are regional inflation differences across the euro countries and so on — but by the end they found common ground, which was that we need growth, investment, and structural reforms. So what thoughts come to mind about this clash of the titans? On my way here I was reading through Björn Wahlroos's piece again, and I was honestly a bit puzzled about what it's actually getting at — because as I read it, he's saying something like: consumer price inflation, or inflation as measured by the consumer price index, isn't really inflation at all; inflation is somehow purely a monetary matter,

[**03:31**](https://www.youtube.com/watch?v=G-vcDQD-lKY&t=211s) a monetary matter, and it's determined by the supply of money and the demand for money. And so all this inflation debate that's been going on out there is basically pointless, because in the end it's the demand and supply of money that determines it. He didn't really say much about where that demand comes from, but supply is the central bank's turf, and that way the central bank can always adjust supply to match demand and bring inflation to the right level. So this is pretty monetarist, isn't it. Yeah, exactly — wasn't it Friedman who said that inflation is always and everywhere a monetary phenomenon? That's what it sounded like. And then also that the euro area is one single monolith, that the ECB just swings its supply hammer from there, and 'don't you worry about the thing' over there in the individual countries, sort of — if, if — I'd say — well, maybe I can comment more broadly here — sorry, Sami — that Wahlroos had taken these Finnish economists to task, so to speak, and used their supposedly flawed understanding of inflation to build the argument that Finnish economic debate is depressing, as it probably has always been in Wahlroos's view, no matter who's making the argument,

[**04:54**](https://www.youtube.com/watch?v=G-vcDQD-lKY&t=294s) but it is of course true that at the moment, especially after the Covid pandemic, there have been these large global supply shocks, and as a result of these lockdown measures there have been disruptions to the world economy, and these have set off various developments that have also affected inflation and people's consumption behavior — changes, when people couldn't get to services, they renovated their gardens and ordered fancier laminate flooring for their bathrooms instead. And so a large amount of demand has shifted from services to these goods, and that has reshaped inflation dynamics over the last few years. And then the second thing is this — the war in Ukraine, the related sanctions, and Russia's decoupling — these are big global supply shocks that have in various ways affected inflation in recent years. And as such, this Wahlroos piece about understanding the true cause of inflation — whether you agree with Wahlroos or not — the fact is that right now everyone in the field is somewhat

[**06:18**](https://www.youtube.com/watch?v=G-vcDQD-lKY&t=378s) confused about where it's really coming from, how long-lasting it is, and whether central banks should now react aggressively or hold back. And even central bankers themselves admit that we're genuinely off on some kind of uncharted tangent [unclear] right now, where the exact causes of inflation aren't understood based on the knowledge we had before these shocks. In a way it was actually reassuring, what Nalle said there — — that he understands perfectly what inflation is and where it comes from, but maybe that explanatory model isn't quite as all-encompassing and exhaustive as it's made out to be. I'm actually used to defining the interest rate the way Nalle defines inflation there. That is, the interest rate is specifically the price of the supply and demand for money, and from there, for all other financial contracts, the price is built up from there once it's taken to the markets. It starts from central bank money, state money, and that's actually quite simple — it's needed for liquidity reasons. That's where the demand comes from, and the central bank then sets the supply, meaning how much money it puts into circulation. And from that comes first the policy rate, that is, the rate on that state money, and then you move up the rate structure, add risk on top, and you get the

[**07:40**](https://www.youtube.com/watch?v=G-vcDQD-lKY&t=460s) rest of the rate structure and eventually even securities prices are built on top of that. But if Nalle calls this inflation, then maybe my question is: what's left — how does he then define the interest rate? Yeah, good point. I think the impression I got was that in Nalle's picture the ECB's supply is like this monetarist euro-disc floating above the 19 euro countries, and the ECB adjusts the size of that blob, and that's what's used to buy goods and services, and it squeezes inflation down to some level. That's the vibe I got from it — it felt like a pretty one-dimensional model, where the supply of money is the number-one criterion. There's maybe no room for the interest rate, or it's just kind of odd, and supply is out there somewhere — what I think is completely missing here is the endogeneity of commercial banks, because it smells like the central bank's push is treated as the only lever, but ultimately it's the commercial banks that create bank deposit money. Yeah, that's exactly right, and that is of course one part of the demand and supply of money that isn't directly in the central bank's hands — we're really talking about the endogenous creation of money. But even there, the base rate is of course quite decisive, because it then affects demand through another channel, since people start thinking about the cost of financing, and that way the central bank, via the interest rate,

[**09:05**](https://www.youtube.com/watch?v=G-vcDQD-lKY&t=545s) is able to control people's appetite for borrowing and maybe also banks' willingness to lend. So — it's really this complex whole, pulling in many directions, and it would be really nice if it were as simple as Nalle presents it, but maybe — maybe it just isn't. Yeah. Let's take a light-hearted one — Jussi, you promised to needle me about this, anyway — so I'll go on the attack first. I got into Helsingin Sanomat's Vision, the sort of Christmas 'stargazing predictions for 2022' piece, and, well, my immortal prediction was 'don't you worry about the thing' — that mortgage borrowers still have good times ahead and rates won't rise, or something close to that — I'm paraphrasing a bit — but that was in December, before the war, right, right, good, good, thanks, you get my point — so there's a tiny bit of an excuse there, but still — the war was actually foreseeable — everyone could see it coming — and what happened today? That 12-month Euribor was at 2.3, so, yeah, Miettinen might get some questions out on the street now that he didn't take out that rate hedge, but I actually agree with you on this — this isn't going to last, so let's check again next summer whether that 12-month Euribor is still sitting at 2.3, and I'd claim

[**10:20**](https://www.youtube.com/watch?v=G-vcDQD-lKY&t=620s) it'll be below that. I don't know by how much, but there are already signs in the air that the global and European economy is starting to crack at the edges, and that the price rises caused by Russia's war of aggression are now also starting to reduce overall demand and weaken economic confidence and the willingness to invest and consume — and through that, central banks are once again facing a new choice. Wonderful. So I got a light forecast from you of falling rates — but does the logic actually work like this: that I see the central bank reacting almost reflexively, sort of chasing after the chains of events that move the economy? If a recession has been brought about, say, through rate hikes — like the ECB, as we're recording this, just added another 0.75 to the policy rate, on top of the Fed's move — so if that ends up killing the economy on top of the inflation, then the central bank doesn't really have much choice but to start rolling the rate back down the hill again, which then boosts economic activity again through some kind of bubble — so is that basically how this potential rate-cutting cycle would go? Well, that's how it's gone since the global financial crisis, and I think that's

[**11:41**](https://www.youtube.com/watch?v=G-vcDQD-lKY&t=701s) how it'll continue going forward too. You can ask — if we've now pulled the European policy rate up toward around 2%, which is probably roughly the ECB's target level at the moment, and then market rates add their own markup on top of that — this kind of nominal interest rate level hasn't been seen here in over a decade, not since sometime in the early 2000s. And since then, quite a lot of debt has accumulated across different sectors, and everyone knows that the more debt there is, the more important it becomes for the economy where that interest rate settles. And right now it really is setting a kind of record, given this new debt situation. So the drop you described there might actually already be fairly likely at this point, given all the other uncertainties we know about. And when we're heading toward maybe a deep recession, even a depression, and the central bank has been given the core task of managing the business cycle, of trying to stabilize the economy — so what else can it do but reverse those rate hikes? By the way, Antti, have you also researched this internal coherence of the euro area? I mean, the Germans, for instance, keep grumbling now and then about the ECB's operations, which are carried out symmetrically for all

[**13:06**](https://www.youtube.com/watch?v=G-vcDQD-lKY&t=786s) regions using the capital key. So, in my view, what's also possibly missing from Wahlroos's theory is the exchange rate. I mean, the dollar has now strengthened past parity. Well, actually, today it might already be back above — so something's happening here, back above one dollar per euro. Yeah. Right. But do you see this exchange rate movement as also, in a sense, removing imported inflation from the US side because of the strong dollar, and maybe adding to it in the euro area, so — is there some kind of game going on here between these two big blocs, the dollar and the euro, and then maybe internal cohesion more generally — I'm just thinking Jussi could weigh in on those currencies — but back to Wahlroos's model, he seems to think about these things in a pretty simple way. Because I remember, back when we put together that collected volume after the financial crisis called 'Kurssi kohti konkurssia' [Course Toward Bankruptcy], well, in that — I was reading an interview with Wahlroos. He'd had some kind of discussion with Mikael Jungner, and there's this immortal line from Wahlroos in it.

[**14:15**](https://www.youtube.com/watch?v=G-vcDQD-lKY&t=855s) He says that, right around then, central banks had just started their unconventional measures after the financial crisis, and things had been brought under control, and Wahlroos simply said that this again shows that capitalism fixes itself — especially if the central bank helps out a little. But the idea in this theory is somehow that inflation is always a monetary phenomenon, and the mandate has been given to the central bank. All the best possible knowledge sits there, and under that cover they're able to make the right decisions. That's how I interpret Wahlroos's remarks. But then, if we go to what Jussi was already talking about, I think there's a genuine risk here that, in a way, the central bank — say, the European Central Bank — does exactly what the law says it must do, and the ECB is an unusual central bank in that it has only this price-stability mandate, with other goals being merely secondary, and the whole system has, in a way, been built around the idea that if you have one single task,

[**15:35**](https://www.youtube.com/watch?v=G-vcDQD-lKY&t=935s) which is maintaining price stability, and price stability is understood as moderate inflation, then in the current situation, where inflation is running wild and the euro area is setting historical records every single month, the central bank can't really react in any way other than by tightening rates. Then, of course, there's been discussion about whether the European Central Bank should have started this tightening cycle before the war in Ukraine even started — whether it got caught off guard by it — but if you just put these two things together — that inflation isn't caused by, or, more generally, this whole monetary policy regime that's been built — there's a bit of an underlying idea that the central bank is this good-times institution, whose job is simply to curb the economy from overheating, and an overheating economy shows up as inflation, and the central bank's job is to take the punch bowl away at just the right moment. So I question this line of thinking in the sense that the economy really isn't overheating in any way, and that inflation isn't caused by any wage-price spiral or excessive fiscal stimulus, but rather by these Covid-driven supply shocks and by the global supply shocks in the energy markets caused by the war in Ukraine and the related sanctions. So, in a way, the central bank is acting

[**16:59**](https://www.youtube.com/watch?v=G-vcDQD-lKY&t=1019s) the way it's mandated to act by law, but these rule-based approaches — or, in this kind of new geopolitical crisis, in a completely new historical situation — I'd question whether central bankers' ideas actually lead to the best possible outcome, because, in my view, for example yesterday's decision, where the European Central Bank raised rates by 75 basis points — that's some kind of panicky overreaction, coming after being criticized for being too late, and then it's like, 'oh yes, yes, we can pull off something historic here.' We're joining the 0.75 crowd now, we dare to do this — but in doing so, the ECB is, in a way, protecting its own credibility while forgetting about the actual state of the economy. And already now there are European central bankers who've said that a recession is coming, that there's nothing we can do about it, that we're simply forced to raise these rates. And I think this shows that there's something wrong with these ideas, with these institutions, if you can only operate with one instrument, one way of thinking, and you can push it to the point where the central bank protects its own credibility by driving the euro area into recession — I think there's something almost Mar—

[**18:22**](https://www.youtube.com/watch?v=G-vcDQD-lKY&t=1102s) — xist, some would say alienated, about this way of operating. That actually ties in well with Sami's first question about the dollar-euro relationship, and the difficulties that a strong US economy is causing right now — or rather, an economy that's much stronger than expected, when people thought the Fed's rapid tightening would bring it to its knees, which hasn't happened. The labor market there is still chugging along, and, well, the housing market is on the verge of collapse, but that isn't showing up yet in the real economy to any great degree. And as long as the US central bank doesn't make that famous 'pivot' — that is, start easing again — because it doesn't see deflationary problems or stagnation coming in its own economy, or a recession or depression, then of course it won't ease its economic or monetary policy in its own country, and then exactly the phenomenon Sami described happens — inflation starts getting exported abroad, because all the weaker currencies — and really, all other currencies are weaker than the US dollar, which remains hegemonic in our world order, even though a lot has happened lately — that's just how it is. So really all the other central banks end up having to follow whatever the Fed does, and since the Fed only looks at

[**19:47**](https://www.youtube.com/watch?v=G-vcDQD-lKY&t=1187s) its own economy, and it's now been tightening like crazy, so the ECB comes under more pressure to do that big 0.75, and that's exactly what came out yesterday, and it was a unanimous decision. Nobody on the Governing Council opposed it, nor did the heads of the national central banks. Everyone agreed this had to be done now. So all the dovishness that had prevailed until now — where the ECB kept saying, let's wait, let's wait, this will sort itself out — — that was thrown out now, and it just got done. And I think that after this there won't be much more to do — instead they'll start pushing that rate back down again — but for now, it got done. We got a bit of room there, and afterward they even promised more hikes to come, but everyone can judge for themselves over the coming weeks whether that's really going to continue. Yeah, someone had crunched the numbers on Lagarde's remarks — based on that promise, the hiking would end in February, meaning hikes would continue until February — but yeah, it's data-dependent, and depends on whether those things actually start happening.

[**20:50**](https://www.youtube.com/watch?v=G-vcDQD-lKY&t=1250s) Maybe I'd add something more global to that — well, Putin decided that we're sniffing at a frozen wolf's tail here [unclear]. So he's cut off gas exports to Europe entirely, which creates yet another kind of supply shock in energy, causing an even more chilling problem on the energy side of inflation. But then China has, I think, often ended up taking the blame — they've brought deflationary pressure by running their goods economy with incredible efficiency and keeping consumer electronics and other everyday goods on a downward real-price trend. So I wonder whether that will still come to the rescue this time. There could also be a bit of bad news, Job-style, coming from the supply side on inflation too — that's at least the feeling I get. China has actually saved Europe by selling us the gas that Russia isn't selling. Storage got filled up a couple of months ahead of the target date, and that's largely come from China this way — China has sold its surplus. Actually, that's a direct answer to that. Last night China's producer price data came out, and it's coming down like a rock — the year-on-year change in the index was already below 3%, and that drop has been going straight downward over the last month or so, and that has a fairly direct effect on what then happens to US consumer prices, so maybe that deflation coming from there

[**22:13**](https://www.youtube.com/watch?v=G-vcDQD-lKY&t=1333s) from the goods market will come to the rescue again this time too, at least partly, and it saves the Fed in the sense that it no longer needs to be so extremely worried about inflation. It's starting to talk a bit in that direction. The financial markets are anticipating this — stock prices start rising, long-term rates start falling — and what that means for Europe: the euro starts to strengthen, since the hawks here have now gotten the upper hand over the doves, and a bold rate hike was made, and overall it's starting to look like the inflation gap between the US and Europe could actually narrow as well, through the exchange rate becoming more favorable. But this is exactly the wolf's-tail problem — since the energy shock hitting Europe is so large, it pulls things in the other direction, and inflation grows again because of that. And that's why the Bank of England and the ECB are actually in the worst position of all right now. A moment of silence, by the way, for Elizabeth's memory. Maybe three seconds was enough. I'm not a monarchist.

[**23:27**](https://www.youtube.com/watch?v=G-vcDQD-lKY&t=1407s) Yeah. Have you heard that Britain's next queen is a man? Honestly, all this woke nonsense these days. Okay. That was entirely Antti's — Antti's own joke. I actually was hoping Charles would become king, and he did become king. Well, now we're getting a bit — a bit off track. I mean the third. Ah, okay. Yeah, well. But Britain has maybe even a bit more inflation worry, since they have to fight over containers crossing the Dover Channel, and that's an additional challenge too. So this is actually an interesting weekend. It wasn't just the ECB's monetary policy decision — there's also actually an energy ministers' meeting today. And if that produces some kind of fix for the European electricity market, like what Liz Truss promised yesterday as prime minister over there in Britain — and that already brought inflation expectations down right away. And if Europe gets a similar technical fix for the electricity market, that would lower inflation expectations here too. So it's possible that by next week things will look a bit sunnier, even for those at the very bottom of the pile.

[**24:37**](https://www.youtube.com/watch?v=G-vcDQD-lKY&t=1477s) Yeah, oil has dropped, which has in turn dropped gas prices for Americans, which is of course the single most important thing in the world over there. But yeah, actually I think these backstop crisis packages that governments — Finland included — have put together, done in Finland, Sweden, Germany, have also removed some of that futures price pressure, so they've probably been a good thing in slowing down that price pressure. So yes, those have helped, and in that market, of course — it's important to get things moving in the right direction, because liquidity is so low there that if it goes up fast, it also comes down fast. Yeah, the marginal price is so darn sensitive there that — well, capitalism, or the market economy, doesn't always work perfectly, you need that liquidity backstop of last resort, some big authority there that ends up saving the situation, almost in an authoritarian way. Hey, you were on that — Sauli Vileen [unclear], on a very popular episode of the Inderes podcast, about central bank capitalism. And I actually also went on Rami Kuurimaa's and Leevi Leivo's show and gave a talk once on the same topic — 'Central Bank Capitalism: Sold Out' — or was it socialism, question mark — but that was a genuinely fresh take, in my view, that this is, in a way, a continuation of the continuum of capitalism, where everyone tries

[**26:01**](https://www.youtube.com/watch?v=G-vcDQD-lKY&t=1561s) in a way to measure success through the accumulation of capital and the accumulation of profits, so it's actually quite logical to call this central bank activity 'central bank capitalism' rather than socialism. Could you run through a bit of that talk again, what you presented to Sauli about the nature of this development of capitalism? Well, this probably comes right out of Antti's and my shared hobby of political economy — Jussi's definitely in on the conceptual side of this hobby too. Yes. But specifically, the whole idea behind the concept of central bank capitalism is this kind of historical-institutional change, and the question of how, if we think of capitalism as this centuries-old economic system built precisely on that logic, the one you just described, and it can be said that it still holds true today, and that the majority of people's economic — and maybe even broader societal — decisions happen somehow through that same accumulation principle. So in that sense it stays the same, but its particular form changes according to how our institutions change over time. So if we start from somewhere around

[**27:15**](https://www.youtube.com/watch?v=G-vcDQD-lKY&t=1635s) 18th-century mercantile capitalism and unpack it from there, then we arrive at this 19th-century finance capitalism. Above all probably in the United States, where railroads were built using heavy financial leverage, debt was taken on, and the banking system was rebuilt from scratch. And global high finance probably already existed even then, though the emphasis kept shifting a bit. And then, in a way, the system ran itself aground in the late 1920s, and that was followed by the next, next big collapse [unclear] above all, of course, in Europe, but then elsewhere too. And after that came the era of welfare-state capitalism, since people wanted to avoid repeating those same problems of unregulated market capitalism — not to repeat them — so now a strong state was needed. And then that too got a kind of backlash, a new sort of finance capitalism, and many call that period — running from the late 1960s —

[**28:20**](https://www.youtube.com/watch?v=G-vcDQD-lKY&t=1700s) to somewhere around the late 1980s — neoliberalization — and that's really the political side of it. And then things moved into this new finance capitalism, one that strongly built up or generated private debt, which then ran aground again in the global financial crisis. And after that, when state institutions were once again needed to help, what emerged as by far the biggest helper of all was the central bank. And that's what this concept rests on, and pretty few people would deny that central banks have been an extremely important institution over this past decade, and remain so. And, well, that and much more is what we talked about with Sauli on that podcast. Let's throw in a little clip here — by the way, since Nalle was mentioned at the start — there was that book, 'The Future of the Euro — Finland's Options,' edited by Vesa Kanniainen, and he was one of the contributors to it, so at its launch event he explained, in a way, this problem with the euro — that you lock in the exchange rate in such a way that the labor-market price can't form properly, because it's rigid downward — so, in Nalle's view and many others' too, the labor-market price only moves upward, it can't adjust other than through cutting employment downward. So, in a way, it might still, to some extent

[**29:46**](https://www.youtube.com/watch?v=G-vcDQD-lKY&t=1786s) work. It could, in a way, generate competitive pressure in the economy that would bring things back into balance. But that very last valve through which this could have worked was closed off precisely by the measures Erkki is referring to there. And after that, this system really has no hope left, unless we get some dramatic program to make the labor markets, above all, function — and let's agree that was the last time anyone got bailed out here. So remember, here we're talking about two different things. On one hand, we're talking about how a design flaw has produced an acute inflammation in the financial system and in the government finances of some countries. That isn't, in itself, solely the euro's fault. The euro's fault is only that it has closed off that obvious, simple way out, which is a dramatic devaluation. These are two separate things. When I say that the euro can't be paired with markets that don't function, because that leads to a situation where prices are locked in place — I'm talking about a different thing than this particular manifestation, this particular symptom of the crisis, which is these sovereign debt crises. And in this

[**30:54**](https://www.youtube.com/watch?v=G-vcDQD-lKY&t=1854s) sense, Alex might be half right that the acute debt crisis is somewhere in the middle of running its course, but that tells you nothing at all about the real underlying sickness — that we've eliminated the price-adjustment mechanism that would make the future possible. Actually, I agree — I think we're sitting here again, some of us looked at these charts Elina is referring to just this morning, and I think we're building a new kind of madness again, because now, once again, political actions have managed to convince the markets that surely no country in the euro area is going to default. Right, and if you believe that, Greek government bonds are more available than ever. They just did a successful bond issue. Go put your money where your mouth is, if you believe it. I — well, in that regard, I've, for instance, been sympathetic to this. Lauri Holappa, your co-author on that book on monetary economics, I was sort of sympathetic to that kind of balance-sheet

[**31:59**](https://www.youtube.com/watch?v=G-vcDQD-lKY&t=1919s) identity thinking, and you've also made your mark on the idea that balance sheets have to balance — meaning someone's money asset is someone else's debt, and that's true as an identity — but it breaks down right there once you have a supranational currency, and that really bothers me quite a lot. In a way I'd find it much easier to accept the Swedish or Swiss model, or even the American model, where everything still belongs to one single state. There, you have the sovereign state and the central bank, and the private and public economy together form a coherent sovereign equation. So what do you make of that — does this idea of 'central bank capitalism' break down because of supranational currencies like this? Well, no, it definitely doesn't just break down from that, but it probably becomes a more complicated institutional complex as a result. But that's actually quite an interesting view, and, in a way, right here, thinking about this wartime economy between Finland and Russia, and the sanctions struggle, I've gotten to think this through, and it's actually a pretty interesting thing — if you consider that Finland has imported far more goods from Russia than it has exported there, which means our trade balance, and current account too, have been in deficit toward Russia, which means Russia has had to somehow finance this deficit

[**33:24**](https://www.youtube.com/watch?v=G-vcDQD-lKY&t=2004s) and how Russia has financed it so far — by accepting euros from Finland, taking in euros, and then depositing them as reserves in its central bank system. And if we still had our own markka, those would be markka-denominated claims sitting at the Russian central bank, but since we have the euro, they're euro-area-wide claims instead, so, in a way, that lets us off the hook to some extent, and makes it Germany's problem too, and Italy's problem too, and so on. So, in that sense, I do get exactly what you're saying, why it muddies this game and scrambles these relationships — because state money, the euro, is a much more flexible debt instrument than some other kinds of securities that would otherwise be used to settle these emerging relationships, and those would be directly tied to that specific nation-state. So in this case too, Finland's debt to Russia would be markka-denominated debt — but in this case there's definitely a big advantage for Finland in that our deficit has actually been financed by the whole of Europe. Yeah. Fresh point. I don't know if Sweden's Riksbank is in trouble now in some way — probably, sure, if this ever gets properly untangled at some point, then, then, then

[**34:51**](https://www.youtube.com/watch?v=G-vcDQD-lKY&t=2091s) the krona-denominated debts would turn up there, but actually there is no krona debt, because they haven't run that deficit. Yeah, yeah. And, well, good point — didn't we, as a single NATO bloc, already decide to freeze Russia's central bank assets? In a way, we probably wouldn't have dared to do that alone as a single independent nation — so in that sense there's real power gained from this supranational construction. But those imbalances still bother me, and then, since they never really get corrected — that Target2 balance just stays irreversibly in surplus and deficit, and that never corrects itself — not even Erkki can fix it. Except Germany, by the way, is now historically trying its best — for the first time in about 30 years its current account went into deficit, though I don't know whether that's gone to other euro-area countries or purely to Russia — but anyway, that's a genuinely fresh angle. About that balance-sheet identity — you already put it in a tweet, that kind of thing, that one person's asset is another's liability —

[**35:55**](https://www.youtube.com/watch?v=G-vcDQD-lKY&t=2155s) identity slide, so explain again why these two things match up. Well, I think I shared today's, or last year's, flows. It was a flow chart — maybe you remember it — I haven't shared the stock charts. Those are much more complicated. But these flow charts are interesting in the sense that, when we talk in Finland about government debt or public-sector debt, what's actually being looked at is the deficit — and that's specifically a flow. So during the year, that figure tells you how much more the state pays out in income flows than it receives in income flows over the year. And, well, the diagram is very simple: whenever there's someone paying out an income, there's someone receiving it. These always have to match, because generally people's money-denominated agreements are made for matching amounts. If I buy a 2-euro coffee from a shop, that's 2 euros gone from me and exactly 2 euros to that shop. So it's also an ontological fact of reality that these flows match up. But then, when you look across sectors, if the public sector is running a deficit — meaning it's paid out more flows than it's received — then

[**37:16**](https://www.youtube.com/watch?v=G-vcDQD-lKY&t=2236s) other sectors must be receiving that as a net benefit. And when you go through everything, the situation in Finland right now looks like this: the corporate sector is accumulating the most surplus, receiving more inflows than it pays out. And basically all the other sectors — households, the state, municipalities, and the social security funds combined — that is, the public sector, is running a deficit, and the foreign sector is roughly in balance, since our current account settled into balance last year. That will, of course, shift again in a worse direction, adding more burden to the state's deficit, because it has to show up correspondingly there, or as growth in the household deficit. So, well, nothing wrong with that — it's just bookkeeping, and then there are various cause-and-effect relationships driving that pattern. Yeah. And maybe on that note — I'm slowly trying to recover from the curse of mercantilism — so, in a way, maybe Germany actually shows that it isn't such a winning strategy at all — at worst you've squeezed your own people for decades and gained nothing from it except a positive Target2 balance that nobody's ever going to pay back to you. So, really, the sensible thing would be to actually increase investment and raise wages at home. Just as we were saying, that euro purchasing power naturally reaches the whole euro area as such, and on top of that, since it's also a strong reserve currency in the world, you can use it to buy things from the whole world too. So

[**38:43**](https://www.youtube.com/watch?v=G-vcDQD-lKY&t=2323s) German households would probably have liked it if they'd had a bit more to spend. Yeah. And gotten even better highways out of it too. Antti, you're often out there at A-studio or elsewhere explaining what the ECB's, uh, top brass have been up to lately — so, following the end of QE, or the winding down or ending of those net purchases, are there any interesting moves coming up? Is it still a political battle? At least I'd seen this one thing that stirred up passions — that the ECB has the option of buying, say, Italian, Greek, and Finnish bonds and selling German and Dutch bonds as a net flow out of that QE portfolio. Well yeah, this is an extremely complicated question, but the QE program, which started in 2015 — the idea behind it was that it's an anti-deflationary instrument — that is, it's meant to accelerate inflation. In the current situation, where inflation is running wild all over the place, it can't be used for that. Then the other one was PEPP, created during the Covid pandemic — its idea was to prevent fragmentation, but also to fight the deflation caused by Covid lockdowns and the pandemic. That program was also ended — I think it was in March

[**40:08**](https://www.youtube.com/watch?v=G-vcDQD-lKY&t=2408s) as far as I understand, because the programs' publicly stated goals no longer applied — the conditions had changed. But then there's this subtle point, as Jussi said, that as a result of high indebtedness we're dependent on favorable financing conditions, and now that inflation is running wild wherever it's running wild, and the European Central Bank is forced to raise rates, that very quickly starts showing up, for instance, as a rise in Italy's debt-servicing costs. So now the ECB has actually done two, two interesting things. First, with the PEPP program, the net purchases aren't being continued — so the program isn't active in that sense. But when bonds get repaid as they mature, the money the ECB, or the member states' national central banks, receives gets reinvested. Now, the ECB's PEPP program differed significantly from the QE program in that it had more flexibility built into it. We could go really deep into this, but the QE program from 2015,

[**41:28**](https://www.youtube.com/watch?v=G-vcDQD-lKY&t=2488s) which was launched then, has already been scrutinized by Germany's Constitutional Court and the EU Court of Justice, where the EU Court has said — those red-robed Karlsruhe judges look like some kind of villains out of a horror movie with those pointy hats on — but specifically the EU Court of Justice said that this QE program is fine as long as it's carried out according to the capital key. And in the PEPP program, one key element was that it could depart from that capital key. The EU Court says the purchases must not benefit — they must be directed at the whole euro area. They must not benefit individual member states, so that it doesn't breach this separation between monetary policy and fiscal policy. And then, on the other hand, that it doesn't commit — what's it called — monetary financing, a breach of the treaties, that it doesn't break the prohibition on monetary financing, but throughout the whole pandemic, this instrument — this element in PEPP that allowed departing from the capital key — it was there, but it wasn't used.

[**42:34**](https://www.youtube.com/watch?v=G-vcDQD-lKY&t=2554s) But now that the ECB has started normalizing its monetary policy — that is, stopped the net purchases and started raising rates — the ECB departed from this — or, how to put it — started making use of this PEPP element, that it's possible to deviate from the capital key. So now we know that in June and July it specifically over-bought Italian, Greek — was it Spanish too — Portuguese, and Finnish bonds, and then, deviating from the capital key, bought less German, French, and Dutch debt. Mm. And this raises an interesting legal question — if this PEPP program was created for a deflationary environment, and we're now in a strongly inflationary one, how can it even be used? Yeah, but by the way, I would have been outraged if Finland had gotten a minus, but because it was a plus, well, I'm such a shameless populist, nationalist kind of person that I was actually delighted that our — our state debt

[**43:39**](https://www.youtube.com/watch?v=G-vcDQD-lKY&t=2619s) is being subsidized by this small break — it made little Sami here rejoice a bit, at least. So, yeah, the ECB is also on little Finland's side — but more broadly, if the ECB has these rules, that you have a prohibition on monetary financing, and Germany always gets annoyed about these programs, then how can it be that the ECB creates a program for a pandemic that deviates from these guardrails set by the EU Court of Justice, and then uses it after the pandemic is over? I think this is a genuinely interesting question, both legally and politically — what does it even mean to have these strict rules constraining the ECB's actions, if the ECB can always, whenever it needs to, create a new program for a new economic situation, and also change that program's rationale as the economic situation changes. So — there's been a complaint filed against this PEPP program — actually, sorry, filed with Germany's Constitutional Court.

[**44:49**](https://www.youtube.com/watch?v=G-vcDQD-lKY&t=2689s) Markus Kerber, the arch-enemy — the ECB's arch-enemy — has surely written yet another fine complaint against it. But Germany's Constitutional Court hasn't yet sent this ultra vires referral. But the next ruling from the European Court of Justice on this PEPP matter is going to be an extreme piece of legal contortion, because history tells us the EU Court is never going to say, of course, that it violated the treaties, and the ECB has, in a sense, the right to interpret its own mandate — but how credibly these institutions can still get through this threshing machine remains to be seen. Yeah. We'll see, because now Germany might be a weaker country again, so maybe they won't have the energy to be such purists anymore, and old-style they'll have to seek some political compromise on this — energy — I've got one provocative theory too, if you think of the ECB as a hedge fund thinking about its own existence, then it maximizes its returns by buying high-yield products — Italian and Greek bonds, say — because if they never default, that maximizes the ECB's cash flow. No — sorry, after all that rambling, what I actually want to say is that the ECB has to prevent a new eurozone crisis, and that, in a way, the ECB is currently trying to push the euro area

[**46:11**](https://www.youtube.com/watch?v=G-vcDQD-lKY&t=2771s) into recession without triggering a new euro-area debt crisis. And that's where PEPP comes in, and TPI too — TPI being yet another new, separate instrument, but let's not get into that now, since we're running out of time. But the ECB has to keep spreads under control at the same time as it tries to curb inflation by pushing the euro area into recession, and that really is a fascinating game central banks are playing right now. One technical and fairly big issue is that European money markets are also built on a repo basis, just like in the US, and there the core collateral is government bonds, and what you want from core collateral is for its price to develop steadily, without big swings. Now that the whole bond market's liquidity situation is really poor, and there's this QT going on — the net purchases being withdrawn — well, everyone's seen that the the intraday price swings are really large, and that then creates fairly big problems for money markets too, since liquidity starts draining away because collateral has to be topped up when prices have moved significantly within a single day. So this brings us to this money-market structure as well, which has been talked about surprisingly little even in Finland — and if you think it through, you can end up concluding that, in the end, these

[**47:31**](https://www.youtube.com/watch?v=G-vcDQD-lKY&t=2851s) quantitative easing programs, or the programs operating on the balance-sheet side, are actually more important in the euro area than interest rate policy itself. It has to be able to stabilize the bond market. Yay. Great. Let's finish up here with this: who was less wrong, Olli Rehn or Nalle Wahlroos — can we get a vote on the question of the causes of inflation, or — — or in this debate here, just giving vague non-answers. Well, I think I liked Olli Rehn's answers a bit more. They were somehow more grounded in reality. Yeah, I'll vote for Olli Rehn too — sorry Nalle, you lost this one. Thank you. My guests today have been Antti Ronkainen and Jussi Ahokas — good luck with your dissertations. Thank you, thank you, thank you.

---

Cite as: Sami Miettinen, Neuvottelija — Wahlroos vs. Rehn: The Monetary Policy Clash | Jussi Ahokas, Antti Ronkainen, https://www.neuvottelija.com/podcast/episodes/157-wahlroos-v-rehn-rahapolitiikka-jussi-ahokas-antti-ronkainen/, 2022-09-11. For quotes include episode 152 and timestamp.