Who’s Rebalancing

Just a quick note. The two largest surplus economies have lately decided to take radically different paths.  China expressed concern for the imbalances lying behind its large current account surplus, and pledged since at least 2009 to re-balance its growth model towards higher domestic demand. I had already discussed that a little more than one year ago, noticing how the challenge for China was to steer away not only from exports, but also from excessive investment. In the same piece I had argued that while China seemed fully conscious of its contribution to the global imbalances that had led to the crisis, Germany had decided to walk the opposite path.

And here we are. With  timely synchronization, we learn that wages in Bavaria will increase  by 5.6% over the next two years,  maybe triggering a more generalized increase. Or maybe not. While in China they increased 17% in the year 2012.

Even taking into account differences in inflation and in growth, the difference is revealing. China is actually playing the game it committed to. Not only it tries to reduce its dependence on foreign demand; but, domestically, it is trying to boost consumption and to curb investment.

In the meantime Germany is stuck with its small-country syndrome: export-led growth and restraints to domestic demand (both public and private). In spite of recent troubles, austerity remains the course Europe is following (with disastrous results). It is telling that even when partially acknowledging that austerity did not bring the fruits she hoped for, Angela Merkel can only suggest, as an alternative, structural reforms to boost competitiveness. Expanding domestic demand has not, is not, and will not be an option for the German government.

The Berlin View is alive and kicking.

Raepetita Iuvant

Yesterday Eurostat published  growth flash estimates for a number of EU countries. As expected, they do not look good. In 2013 Q1 the eurozone has lost 1 per cent of its GDP with respect to the first quarter of 2012 (-0.7 for the EU 27). It is the longest recession since the inception of the single currency, and it brings with it record unemployment at 12.1 per cent.

Not surprising, I said, because in spite of increasing talks about softened austerity, austerity ain’t over. In many countries, government final consumption in real terms (the G in national accounting equations, just to be clear) sharply decreased. And this is, surprise, correlated with subsequent growth:

Countercyclical no More

Browsing national accounts may be an inexhaustible source of insight on the current debate about austerity. Take this figure, which shows the evolution of real GDP and of its components for the US and the EMU, making the first quarter of 2008 equal to 100.

I tracked in particular the evolution of private (consumption plus investment) and public expenditure on good and services.

It Ain’t Over ’til It’s Over

Update: just a link to Wolfgang Munchau, who seems to make a similar argument.

Austerity partisans had a couple of rough weeks, with highlights such as the Reinhart and Rogoff blunder, and Mr Barroso’s acknowledgement that the European periphery suffers from austerity fatigue.
In spite of the media trumpeting it all over the place, and proclaiming the end of the austerity war, it is hard to believe that eurozone austerity will be softened. Sure, peripheral countries will obtain some (much needed) breathing space. But this is neither a necessary nor a sufficient condition for a significant policy reversal in the EMU.

Cockroach Ideas and Weak Arguments

Helene Mees in a Project Syndicate Comment weighs into the dispute between Paul Krugman and the Commission officials, siding with Rehn and his people.
Mees’ criticism of Krugman is two-sided. First, she argues, Krugman omits to say that the OMTs program is subject to heavy conditionality, and that the signature of the fiscal compact was a necessary precondition for the adoption of the program. I don’t get it. The ECB is very vocal on austerity and on structural reforms, and it is clear that the OMTs program was adopted only at the very last minute, facing the perspective of eurozone collapse. A number of economists, including myself, welcomed the OMTs while criticizing the heavy conditionality attached to it. The very fact that the OMTs was reluctantly adopted shows that even austerity partisans cannot deny the fact that the EMU is desperately lacking a proper lender of last resort, of which the OMT is a pale surrogate. The more non-Keynesian institutions are forced to adopt Keynesian solutions, the more Krugman’s point is vindicated. I fail to see how the opposite could be true.

The Commission on Portugal: Is This for Real?

A quick note on Portugal. Let’s start from three facts:

• Austerity did not work. Portugal is in a recessionary cycle. The economy will shrink by 2.3 per cent this year, more than twice as much as the previous government forecast (and the slowdown of exports to the rest of the eurozone, is not helping).
• Austerity is self defeating: the deficit-to-GDP ratio widened from 4.4 per cent in 2011 to 6.4 per cent last year, and is forecasted to be 5.5 per cent in 2013. Far above the target of 3 per cent that the government had agreed with the Troika. My guess is that it will be even larger than that.
• The magic wand of confidence is not magic. The budgetary cuts did not boost private spending, and expectations remain gloomy. The Financial Times article cites the Portuguese daily Público writing “Portugal has entered a recessionary cycle. People have no reason to believe the future will be any better. The [adjustment] programme has failed and has to be changed.” So long for the confidence fairy…

Is this surprising? Not at all. Austerity is likely to be recessionary and self-defeating, when a number of conditions are met. (a) Monetary policy is at the zero lower bound, and cannot compensate the recessionary effects of budget cuts with interest rate reductions. (b) Trading partners are also in a slump (and/or they are also implementing austerity measures), and hence exports can not substitute for decreased domestic demand. (c) The private sector is deleveraging, and subject to a credit crunch.

Fear and Confusion in Frankfurt

I must say I am puzzled by today’s decision of the ECB to leave rates unchanged. It simply does not fit with what Mario Draghi said during the press conference. Let me quote him.

Inflation expectations for the euro area continue to be firmly anchored in line with our aim of maintaining inflation rates below, but close to, 2% over the medium term. At the same time, weak economic activity has extended into the early part of the year and a gradual recovery is projected for the second half of this year, subject to downside risks. Against this overall background our monetary policy stance will remain accommodative for as long as needed.

If words actually mean what they mean, Draghi informed us that (a) inflation, and inflation expectations, are in line with forecasts and objectives; (b) at the same time, economic activity is weaker than expected, and the future recovery is at risk; (c) the ECB is willing to have an accommodative monetary stance.
Two considerations: first, the king is naked; it was obvious from the very beginning that the recovery in the second half of the year was not in the cards. I already discussed the systematic bias in official forecasts. It turns out that simply saying to markets that things will go well, is not sufficient to make them act accordingly. The confidence fairy, as Krugman calls it, is nowhere to be seen. I would add that this systematic bias risks making EMU institutions less credible, and hence further weaken their capacity to anchor private sectors’ expectations…
And then the puzzle: if inflation is under control, and if economic activity is weak, and if the ECB deems accommodation to be needed, why, why on earth are rates kept constant? Should we remind to Mario Draghi what is written in article 127 of the Lisbon Treaty?

The primary objective of the European System of Central Banks, hereinafter referred to as “ESCB”, shall be to maintain price stability. Without prejudice to the objective of price stability, the ESCB shall support the general economic policies in the Union with a view to contributing to the achievement of the objectives of the Union as laid down in Article 3 of the Treaty on European Union.

Among the general policies that the ECB should support there is growth and employment. And lowering the rates today would certainly not lead to “prejudice to the objective of price stability”

Why is the ECB so frightened to send the signal to markets that it is ready to boost economic activity? Is there an hidden agenda we are unaware of?