Leaks in the Dam?

Interesting things happened this morning. I assisted to one of the presentations of the OECD interim assessment. There is nothing very new in the assessment, that concerning the eurozone, can be summarized as follows

• The outlook remains negative (while the rest of the OECD countries are doing better)
• There is still room for monetary accommodation
• This monetary accommodation may not benefit the countries that need it more, because the transmission mechanism of monetary policy is still not fully working
• The Cyprus incident shows that there is a desperate (this I added) need of a fully fledged banking union
• EMU countries need to continue on the path of fiscal stabilization, even if automatic stabilizers should be allowed to fully play their role, even at the price of missing nominal targets

Cyprus. Been There, Seen That

A small country is on the verge of bankruptcy. It is so small that the amount of money needed to save it (17bn euros) amounts to less than 0.12 per cent of the eurozone GDP (no typos here. It is around 30 euros per European citizen).
Been there, seen that. Just three years ago in another small country, Greece. At the time, procrastination, self interest, ineptitude, unpreparedness, made the small problem become huge. And we are all still paying the bill. The Greek crisis management was so successful that our leaders are happily embarking in the same dynamics: improvised, dangerous, half-baked solutions, supposedly designed to avoid free riding (the protestant syndrome, once again) and in fact destabilizing the whole system.

There is no need for me to repeat what has been understood everywhere except, as usual, in Berlin, Frankfurt and Brussels: the tax on deposits breaks an implicit pact between governments and depositors, and fragilizes the banking systems of the whole periphery of the eurozone.

Wishful Thinking

Yesterday I published a note on OFCE le blog (in French), analyzing one possible outcome of the recent Italian elections: A center-left minority government, with external support of the Cinque Stelle movement led by comedian Beppe Grillo. The last part of the post argues that if a convergence between the Democratic Party and Beppe Grillo were to be found (at the moment the scenario is rather unlikely), it would happen on a number of progressive issues, like for example minimum citizenship income. But then, I conclude, this has implications for Europe as a whole. Here is a translation of the last paragraphs: It is clear  that the convergence could hardly happen within the bounds of the current fiscal consolidation. An agreement would therefore need a prior reversal of austerity that, it is worth repeating, was disavowed by the voters. This would not be easy for the Democratic Party that, like the Socialist Party in France, made the choice of fiscal discipline, and has kept a very ambiguous position along all the electoral campaign. But in turn, this has implications for Europe as a whole. European leaders in the next weeks may face a choice between demanding that Italy stays the course of fiscal consolidation, condemning the third economy of the eurozone to political paralysis and probably social chaos; or, accept that a new government is formed, that will most likely abandon austerity.  In both cases it will be impossible to act as if nothing had happened. Europe could be forced to rethink its own economic strategies, that are failing not only in Italy. An some countries reluctantly embracing fiscal consolidation (France to name one) could take the opportunity to challenge austerity as the only policy for growth.

Let’s be clear, here. I am totally aware that at the moment this is nothing more than wishful thinking. But hey, you never know…

It’s the Denominator, Stupid!

This weekend’s news was the downgrade of the UK by Moody’s. Chancellor Osborne took this as a sign that austerity should be strengthened even more, probably because he had little choice (never put all your eggs in one basket…). And yet, if only somebody in Downing Street bothered going through the text, they would have read this:

The key interrelated drivers of today’s action are:
1. The continuing weakness in the UK’s medium-term growth outlook, with a period of sluggish growth which Moody’s now expects will extend into the second half of the decade;
2. The challenges that subdued medium-term growth prospects pose to the government’s fiscal consolidation programme, which will now extend well into the next parliament;
3. And, as a consequence of the UK’s high and rising debt burden, a deterioration in the shock-absorption capacity of the government’s balance sheet, which is unlikely to reverse before 2016.

Thus, Moody’s analysts clearly state the direction of causality:

The Spring is Nice, but then Comes the Fall

The much awaited European Commission Forecasts for 2013-14 are out. What do they say, in a sentence? That the situation is grim, but that the EU is gradually overcoming the headwinds. So that, surprise, surprise, the second half of the year will be better.
I guess we already heard that.  Every Spring forecast depicts a negative situation, and predicts an improvement in the Fall. And every year the Fall turn out as mother nature meant it to be, worse than the Spring.

I made a back-of-the-envelope exercise. The following figure depicts the forecasts error for each year of the Commission’s Eurozone GDP growth estimates from 3 different time horizons. The same year Fall forecast, the same year Spring forecast, and the previous year Fall forecast. To make it clearer, the three bars for say 2012, represent the forecast error of the Fall 2011 forecast (blue), of the Spring 2012 forecast (red), and of the Fall 2012 forecast (yellow).

I am not expert enough to judge whether these errors are “large” or “small”. Forecasting is a very difficult exercise, most notably in times of acute crises (the Commission underestimated both the severity of the recession in 2009, and the rebound of 2010). Yet, even a casual observer like me cannot help but notice two things:

1. 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.
2. 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 (and in 2008-09-10-11…). November!

Taken together these two things seem to point to a political use of the Commission’s forecasts. Being overoptimistic, the people in Brussels first try to deflect criticisms of the austerity measures they help impose to most European countries; and second, probably, they hope to trigger the confidence fairy that is supposed to compensate fiscal consolidation and lift the EMU economy from the hole in which it put itself. “Look, things will be better, let’s go out and spend!”.  Vain attempt, if you ask me…

If we take the average error of the past 5 years, and assume that the Commission current forecasts are equally wrong (ok, this is just a game, it really is not rigorous!), we have this:

Then I have my own forecast for growth in the EMU for 2013. It ranges from -0.54% to -1.14%. The Commission forecasts -0.3%. We’ll see…

Stones Keep Raining

Paul Krugman  hits hard on one of the most cherished american myths, the golden years of Reaganomics. He shows that using the middle class as a benchmark (the median family income of the economy), the Reagan decade saw a disappointing performance; this, not only if compared to the longest expansion in post war history, during the Clinton presidency, but also with respect to the much less glorious 1970s.

But, maybe, Krugman is telling a story of inequality, and not of sluggish growth. The fact that median income did not grow much during the Reagan years may not mean that growth was not satisfactory, but simply that somebody else grasped the fruits.

For curiosity, I completed his figure with average yearly growth rates for two other series: Income of the top 5% of the population, and the growth rate of the economy.

Well, it turns out that Reaganomics yielded increasing inequality and unsatisfactory growth. And well beyond that, median income consistently under-performed economic growth in the past forty years.

What seems extremely robust is the performance of the top 5% of the population. Their income increased significantly more than output over the past decades. It is striking  in particular, how the very wealthy managed to cruise through the current crisis, when income of the middle class was slashed.

Nothing new, Ken Loach in 1993 said it beautifully: it is always raining stones on the working class. But I guess it does no harm to remind it from time to time…

Surprise! Spillovers Exist!

Eurostat GDP data are out. The eurozone is in recession, and it is worse than expected (-0.6% in 2012). Austerity is not working, and is recessionary. Wow, who would have said it…

Seriously, so long for the widespread optimism of a few weeks ago. The crisis is not over, we actually are in the middle of it. The way I see it, things will get worse before they get better (if they do get better).

Also interesting, Germany’s export-led growth strategy is  panting. The fourth quarter of 2012 was rather bad (worse than in France, for example), and this is due to lower investment on one side, and to weaker trade (exports fell more than imports). Here is an excerpt of today’s press release of the German statistical office, Destatis:

In a quarter-on-quarter comparison (adjusted for price, seasonal and calendar variations), signals from the domestic territory were rather mixed according to provisional calculations: household and government final consumption expenditure went up slightly. In contrast, gross fixed capital formation in construction decreased a bit and gross fixed capital formation in machinery and equipment was down markedly on the third quarter of 2012. The decline of the gross domestic product at the end of 2012 was mainly due to the comparably weak German foreign trade: in the final quarter of 2012, exports of goods went down much more than imports of goods.

Germany stubbornly refuses to accommodate austerity in the periphery with a domestic impulsion. This makes adjustment for the rest more painful, and impacts expectations at home. This is why investment dropped significantly. My take on this is that if Germany had been only moderately more expansionist at home, expectations would not have been dashed (even if slightly increasing, in January the IFO index of German business confidence stagnates at around 104 at the moment, after hitting an all time high of 115.40 in February of 2011). And investment figures would be substantially better.

So, we learned today that austerity does indeed reduce growth, and that it spills to other countries. Two surprises in one day. It will need a hell of an effort to forget all of this before tomorrow!