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ECB: Great Expectations

June 5, 2014 3 comments

After the latest disappointing data on growth and indeflation in the Eurozone, all eyes are on today’s ECB meeting. Politicians and commentators speculate about the shape that QE, Eurozone edition, will take. A bold move to contrast lowflation would be welcome news, but a close look at the data suggests that the messianic expectation of the next “whatever it takes” may be misplaced.

Faced with mounting deflationary pressures, policy makers rely on the probable loosening of the monetary stance. While necessary and welcome, such loosening may not allow embarking the Eurozone on a robust growth path. The April 2014 ECB survey on bank lending confirms that, since 2011, demand for credit has been stagnant at least as much as credit conditions have been tight. Easing monetary policy may increase the supply for credit, but as long as demand remains anemic, the transmission of monetary policy to the real economy will remain limited. Since the beginning of the crisis, central banks (including the ECB) have been very effective in preventing the meltdown of the financial sector. The ECB was also pivotal, with the OMT, in providing an insurance mechanism for troubled sovereigns in 2012. But the impact of monetary policy on growth, on both sides of the Atlantic, is more controversial. This should not be a surprise, as balance sheet recessions increase the propensity to hoard of households, firms and financial institutions. We know since Keynes that in a liquidity trap monetary policy loses traction. Today, a depressed economy, stagnant income, high unemployment, uncertainty about the future, all contribute to compress private spending and demand for credit across the Eurozone, while they increase the appetite for liquidity. At the end of 2013, private spending in consumption and investment was 7% lower than in 2008 (a figure that reaches a staggering 18% for peripheral countries). Granted, radical ECB moves, like announcing a higher inflation target, could have an impact on expectations, and trigger increased spending; but these are politically unfeasible. It is not improbable, therefore, that a “simple” quantitative easing program may amount to pushing on a string. The ECB had already accomplished half a miracle, stretching its mandate to become de facto a Lender of Last Resort, and defusing speculation. It can’t be asked to do much more than this.

While monetary policy is given almost obsessive attention, there is virtually no discussion about the instrument that in a liquidity trap should be given priority: fiscal policy. The main task of countercyclical fiscal policy should be to step in to sustain economic activity when, for whatever reason, private spending falters. This is what happened in 2009, before the hasty and disastrous fiscal stance reversal that followed the Greek crisis. The result of austerity is that while in every single year since 2009 the output gap was negative, discretionary policy (defined as change in government deficit net of cyclical factors and interest payment) was restrictive. In truth, a similar pattern can be observed in the US, where nevertheless private spending recovered and hence sustained fiscal expansion was less needed. Only in Japan, fiscal policy was frankly countercyclical in the past five years.

As Larry Summers recently argued, with interest rates at all times low, the expected return of investment in infrastructures for the United States is particularly high. This is even truer for the Eurozone where, with debt at 92%, sustainability is a non-issue. Ideally the EMU should launch a vast public investment plan, for example in energetic transition projects, jointly financed by some sort of Eurobond. This is not going to happen for the opposition of Germany and a handful of other countries. A second best solution would then be for a group of countries to jointly announce that the next national budget laws will contain important (and coordinated) investment provisions , and therefore temporarily break the 3% deficit limit. France and Italy, which lately have been vocal in asking for a change in European policies, should open the way and federate as many other governments as possible. Public investment seems the only way to reverse the fiscal stance and move the Eurozone economy away from the lowflation trap. It is safe to bet that even financial markets, faced with bold action by a large number of countries, would be ready to accept a temporary deterioration of public finances in exchange for the prospects of that robust recovery that eluded the Eurozone economy since 2008. A change in fiscal policy, more than further action by the ECB, would be the real game changer for the EMU. But unfortunately, fiscal policy has become a ghost. A ghost that is haunting Europe…

Wrong Debates

May 9, 2014 1 comment

Paul Krugman has a short post on the Eurozone, today (I’d like him to write more about us; he has been too America-centered lately), pointing out that the myth of fiscal profligacy is, well, just a myth. in fact, he argues, the only fiscally irresponsible country, in the years 2000 was Greece. It is maybe worth reposting here a figure that from an old piece of this blog, that since then made it into all my classes on the Euro crisis: Fig1PostMArch16
The figure shows the situation of public finances in 2007, against the Maastricht benchmark (3% deficit and 60% debt) before the crisis hit. As Krugman says, only one country of the so-called PIIGS  (the red dots) is clearly out of line, Greece. Portugal is virtually like France, and Spain and Ireland way better than most countries, including Germany. Italy has a stock of old debt, but its deficit in 2007 is under control.

So Krugman is right in reminding us that fiscal policy per se was not a problem before the crisis; And yet, what he calls fiscal myths, have shaped policies in the EMU, with a disproportionate emphasis on austerity. And even today, when economists overwhelmingly discuss unconventional measures available to the ECB to contrast deflation, fiscal policy is virtually absent from the debate and continued fiscal consolidation is taken for granted. I will write more on this in the next days, but it is striking how we aim at the wrong target.

Reforming Europe

May 6, 2014 1 comment

I just finished editing a collective volume, in English and in French, on possible ways to reform Europe. Here is the blog post that presents it:

What Reforms for Europe?

by Christophe BlotOlivier RozenbergFrancesco Saraceno  et Imola Streho 

From May 22 to May 25, Europeans will vote to elect the 751 Members of the European Parliament. These elections will take place in a context of strong mistrust for European institutions. While the crisis of confidence is not specifically European, in the Old Continent it is coupled with the hardest crisis since the Great Depression, and with a political crisis that shows the incapacity of European institutions to reach decisions. The issues at stake in the next European elections, therefore, have multiple dimensions that require a multidisciplinary approach. The latest issue of the Debates and Policies Revue de l’OFCE series (published in French and in English), gathers European affairs specialists – economists, law scholars, political scientists – who starting from the debate within their own discipline, share their vision on the reforms that are needed to give new life to the European project. Our goal is to feed the public debate through short policy briefs containing specific policy recommendations. Our target are obviously the candidates to the European elections, but also unions, entrepreneurs, civil society at large and, above all, citizens interested by European issues.

In the context of the current crisis, the debate leading to the next European elections seems to be hostage of two opposing views. On one side a sort of self-complacency that borders denial about the crisis that is still choking the Eurozone and Europe at large. According to this view, the survival of the euro should be reason enough to be satisfied with the policies followed so far, and the European institutions evolved in the right direction in order to better face future challenges.

At the opposite, the eurosceptic view puts forward the fundamental flaws of the single currency, arguing that the only way out of the crisis would be a return to national currencies. The different contributions of this volume aim at going beyond these polar views. The crisis highlighted the shortcomings of EU institutions, and the inadequacy of economic policies centered on fiscal discipline alone. True, some reforms have been implemented; but they are not enough, when they do not go in the wrong direction altogether. We refuse nevertheless to conclude that no meaningful reform can be implemented, and that the European project has no future.

The debate on Europe’s future and on a better and more democratic Union needs to be revived. We need to discuss ways to implement more efficient governance, and public policies adapted to the challenges we face. The reader nevertheless will not find, in this volume, a coherent project; rather, we offer eclectic and sometimes even contradictory views on the direction Europe should take. This diversity witnesses the necessity of a public debate that we wish to go beyond academic circles and involves policy makers and citizens. Our ambition is to provide keys to interpret the current stakes of the European debate, and to form an opinion on the direction that our common project should take.

The volume can be downloaded  in French and in English, and for free!!

 

ECB: One Size Fits None

March 31, 2014 18 comments

Eurostat just released its flash estimate for inflation in the Eurozone: 0.5% headline, and 0.8% core. We now await comments from ECB officials, ahead of next Thursday’s meeting, saying that everything is under control.

Just this morning, Wolfgang Münchau in the Financial Times rightly said that EU central bankers should talk less and act more. Münchau also argues that quantitative easing is the only option. A bold one, I would add in light of todays’ deflation inflation data. Just a few months ago, in September 2013, Bruegel estimated the ECB interest rate to be broadly in line with Eurozone average macroeconomic conditions (though, interestingly, they also highlighted that it was unfit to most countries taken individually).

In just a few months, things changed drastically. While unemployment remained more or less constant since last July, inflation kept decelerating until today’s very worrisome levels. I very quickly extended the Bruegel exercise to encompass the latest data (they stopped at July 2013). I computed the target rate as they do as

Target=1+1.5\pi_{core}-1(u-\overline{u}).

(if you don’t like the choice of parameters, go ask the Bruegel guys. I have no problem with these). The computation gives the following:

EMU_Taylor_March_2014

Using headline inflation, as the ECB often claims to be doing, would of course give even lower target rates. As official data on unemployment stop at January 2014, the two last points are computed with alternative hypotheses of unemployment: either at its January rate (12.6%) or at the average 2013 rate (12%). But these are just details…

So, in addition to being unfit for individual countries, the ECB stance is now unfit to the Eurozone as a whole. And of course, a negative target rate can only mean, as Münchau forcefully argues, that the ECB needs to get its act together and put together a credible and significant quantitative easing program.

Two more remarks:

  • A minor one (back of  the envelope) remark is that given a core inflation level of 0.8%, the current ECB rate of 0.25%, is compatible with an unemployment gap of 1.95%. Meaning that the current ECB rate would be appropriate if natural/structural unemployment was 10.65% (for the calculation above I took the value of 9.1% from the OECD), or if current unemployment was 11.5%.
  • The second, somewhat related but more important to my sense, is that it is hard to accept as “natural” an unemployment rate of 9-10%. If the target unemployment rate were at 6-7%, everything we read and discuss on the ECB excessively restrictive stance would be significantly more appropriate. And if the problem is too low potential growth, well then let’s find a way to increase it

Commission Forecasts Watch – March 2014 Edition

March 13, 2014 1 comment

Last week the Commission published its second flash estimates for 2013 GDP growth. This allows to update an earlier exercise I had made on forecast errors by the Commission (around this time last year). This is what I had noticed at the time:

The Commission tends to be overly optimistic, and forecasts turn out to be in general higher than actual values. It should not be like this. While I expect a government to inflate a bit the figures, a non-partisan, technocratic body should on average be correct.
Related, it is also surprising that in November of the same year the Commission is still consistently overoptimistic (yellow bar). Let me restate it. This means that in November 2012 the Commission made a mistake on GDP growth for 2012. November!

I had concluded that there was a likely political bias in the Commission’s forecasts, with excessive optimism used to deflect criticisms of austerity. I also ventured in a quick and dirty estimate of the range for GDP growth in 2013, based on the Commission’s past errors. Actual growth turned out to be -0.5%, i.e. at the lower bound of my range (and below the forecast of the time by the Commission, that was -0.3%). I must nevertheless confess that my range was rather wide…

But what about this year? Read more

Wanted: German Inflation

March 6, 2014 7 comments

The latest Eurostat release on inflation shows that the Eurozone, and the EU at large, keep flirting with deflation. This happens mostly because peripheral countries have near-zero inflation rates.  Strikingly, no EU country had, in January, annual inflation rates above the  2% ECB target (Finland and the UK stood at 1.9%). Deflation is a problem for debtors, who see the real value of their debt increase. It is a problem for macroeconomic policy (in particular monetary policy). But it is also a problem for rebalancing. The imbalances that built over the period 1999-2007 show up in diverging inflation rates and labour costs. Take the former, from Eurostat data: Read More

Greek Tragedies, 2014 Edition

February 28, 2014 10 comments

Last week’s publication of a Lancet article1 on the effect of austerity on Greek public health  made a lot of noise (for those who know Italian, I suggest reading the excellent Barbara Spinelli, in La Repubblica).

The Lancet article sets the tone since the abstract, talking of “mounting evidence of a Greek public health tragedy”. It is indeed a tragedy, that highlights how fast social advances may be reversed, even in an advanced economy.

Some time ago (March 2012) I had titled a post “Greek Tragedies“. Mostly for my students, I had collected data on Greek macroeconomic variables. I concluded that austerity was self-defeating, and that at the same time it was imposing extreme hardship on Greek citizens. Of course one needed not be a good economist to know what was going on. It was enough not to work at the Commission or in Germany… But the Lancet article also allows to substantiate another claim I made at the time, i.e. that austerity would also have enormous impact in the long run. It is weird to quote myself, but here is my conclusion at the time:

Even more important, investment (pink line) was cut in half since 2007. This means that Greece is not only going through depressed growth today. But it is doing it in such a way that growth will not resume for years, as its productive capacity is being seriously dented.

What makes it sad, besides scary, is that behind these curves there are people’s lives. And that all this needed not to happen.

I think it is time for an update of the figure on the Greek tragedy. And here it is:

GreekTragediesMark2I said in 2012 that investment cut in half spelled future tragedy. Two years later it is down 14 more points, to 36% of 2007 levels. I am unsure the meaning of this is clear to everybody in Brussels and Berlin: when sooner or later growth will resume, the Greek will look at their productive capacity, to discover it melted. They will be unable to produce, even at the modest pre-crisis levels,without running into supply constraints and bottlenecks. I am ready to bet that at that time some very prestigious economist from Brussels will call for structural reforms to “free the Greek economy”. By the way, seven years into the crisis, the OECD keeps forecasting negative growth together with unsustainable (and growing) debt.

I also added unemployment to my personal “Greek Tragedy Watch”: GreekTragediesMark2_2Terrifying absolute numbers (almost 30% unemployment overall, youth unemployment around 60%, more than that for women!). And absolutely no trend reversal in sight. A final consideration, related to the melting of the capital stock. How much of this enormously high unemployment, is evolving into structural? How many of the unemployed will the economy be able to reabsorb, once it starts growing again? Not many, I am afraid, as there is no capital left.

Not bad as an assessment of austerity… And yet, just this morning the German government complained for a very limited softening of austerity demands.  Errare umanum est, perseverare autem diabolicum…

 

1. Kentikelenis, Alexander, Marina Karanikolos, Aaron Reeves, Martin McKee, and David Stuckler. 2014. “Greece’s Health Crisis: From Austerity to Denialism.” The Lancet 383 (9918) (February): 748–753. Back

Fiscal Expansion or What?

January 21, 2014 3 comments

The newly born Italian magazine Pagina99 published a piece I wrote on rebalancing in Europe after the German elections. Here is an English version.

The preliminary estimates for 2013 released by the German Federal Statistical Office, depict a mixed picture. Timid signs of revival in domestic demand do not seem able to compensate for the slowdown in exports to other countries in the euro zone, still mired in weak or negative growth rates. The German economy does not seem able to ignore the economic health of its European partners. In spite of fierce resistance of Germany policymakers, there is increasing consensus that the key to a durable exit from the Eurozone crisis can only be found in restoring symmetry in the adjustment following the crisis. The reduction of expenditure and deficits in the Eurozone periphery, that is currently happening, needs to be matched by an increase of expenditure and imports by the core, in particular by the Netherlands and Germany (Finland and Austria have actually drastically reduced their trade surpluses). In light of the coalition agreement signed by the CDU and the SPD, it seems unlikely that major institutional innovation will happen in the Eurozone, or that private demand in Germany will increase sufficiently fast to have an impact on imbalances at the aggregate level. This leaves little alternative to an old-fashioned fiscal expansion in Germany.

The Eurozone reaction to the sovereign debt crisis, so far, has focused on enhancing discipline and fiscal restraint. Germany, the largest economy of the zone, and its largest creditor, was pivotal in shaping this approach to the crisis. The SPD, substantially shared the CDU-Liberal coalition view that the crisis was caused by fiscal profligacy of peripheral member countries, and that little if any risk sharing should be put in place (be it a properly functioning banking union, or some form of debt mutualisation). The SPD also seems to support Mrs Merkel’s strategy of discretely looking elsewhere when the ECB is forced to stretch its mandate to respond to exceptional challenges, while refusing all discussion on introducing the reform of the bank statute in a wider debate on Eurozone governance. This consensus explains why European matters take relatively little space in the 185 pages coalition agreement.

This does not mean that the CDU-SPD government will have no impact on Eurozone rebalancing. The most notable element of the coalition agreement is the introduction of a minimum wage that should at least partially attenuate the increasing dualism of the German labour market. This should in turn lead, together with the reduction of retirement age to 63 years, to an increase of consumption. The problem is that these measures will be phased-in slowly enough for their macroeconomic impact to be diluted and delayed.

Together with European governance, the other missing character in the coalition agreement is investment; this is surprising because the negative impact of the currently sluggish investment rates on the future growth potential of the German economy is acknowledged by both parties; yet, the negotiations did not include direct incentives to investment spending. The introduction of the minimum wage, on the other hand, is likely to have conflicting effects. On the one hand, by reducing margins, it will have a negative impact on investment spending. But on the other, making labour more expensive, it could induce a substitution of capital for labour, thus boosting investment. Which of these two effects will prevail is today hard to predict. But it is safe to say that changes in investment are not likely to be massive.

To summarize, the coalition agreement will have a small and delayed impact on private expenditure in Germany. Similarly, the substantial consensus on current European policies, leaves virtually no margin for the implementation of rebalancing mechanisms within the Eurozone governance structure.

Thus, there seems to be little hope that symmetry in Eurozone rebalancing is restored, unless the only remaining tool available for domestic demand expansion, fiscal policy, is used. The German government should embark on a vast fiscal expansion program, focusing on investment in physical and intangible capital alike. There is room for action. Public investment has been the prime victim of the recent fiscal restraint, and Germany has embarked in a huge energetic transition program that could be accelerated with beneficial effects on aggregate demand in the short run, and on potential GDP in the long run. Finally, Germany’s public finances are in excellent health, and yields are at an all-times low, making any public investment program short of pure waste profitable. Besides stubbornness and ideology, what retains Mrs Merkel?

Mario Draghi is a Lonely Man

January 10, 2014 7 comments

I just read an interesting piece by Nicolò Cavalli on the ECB and deflationary risks in the eurozone. The piece is in Italian, but here is a quick summary:

  • Persisting high unemployment, coupled with inflation well below the 2% target, put deflation at the top of the list of ECB priorities.
  • Mario Draghi was adamant that monetary policy will remain loose for the foreseeable horizon.
  • As we are in a liquidity trap, the effect of quantitative easing on economic activity has been limited (in the US, UK and EMU alike).
  • Then Nicolò quotes studies on quantitative easing in the UK, and notices that, like the Bank of England, the ECB faces additional difficulties, linked to the distributive effects of accommodating monetary policy:
    • Liquidity injections inflate asset prices, thus increasing financial wealth, and the value of large public companies.
    • Higher asset prices increase the opportunity costs of lending for financial institutions, that find it more convenient to invest on stock markets. This perpetuates the credit crunch.
    • Finally, low economic activity and asset price inflation depress investment, productivity and wages, thus feeding the vicious circle of deflation.

Nicolò concludes that debt monetization seems to be the only way out for the ECB. I agree, but I don’t want to focus on this. Read more