Yesterday I quickly commented the disappointing growth data for Germany and for the EMU as a whole, whose GDP Eurostat splendidly defines “stable”. This is bad, because the recovery is not one, and because we are increasingly dependent on the rest of the world for that growth that we should be able to generate domestically.
Having said that, the real bad news did not come from Eurostat, but from the August 2014 issue of the ECB monthly bulletin, published on Wednesday. Thanks to Ambrose Evans-Pritchard I noticed the following chart ( page 53):
The interesting part of the chart is the blue dotted line, showing that the forecasters’ consensus on longer term inflation sees more than a ten points drop of the probability that inflation will stay at 2% or above. Ten points in just a year. And yet, just a few pages above we can read:
According to Eurostat’s flash estimate, euro area annual HICP inflation was 0.4% in July 2014, after 0.5% in June. This reflects primarily lower energy price inflation, while the annual rates of change of the other main components of the HICP remained broadly unchanged. On the basis of current information, annual HICP inflation is expected to remain at low levels over the coming months, before increasing gradually during 2015 and 2016. Meanwhile, inflation expectations for the euro area over the medium to long term continue to be firmly anchored in line with the aim of maintaining inflation rates below, but close to, 2% (p. 42, emphasis added)
The ECB is hiding its head in the sand, but expectations, the last bastion against deflation, are obviously not firmly anchored. This can only mean that private expenditure will keep tumbling down in the next quarters. It would be foolish to hope otherwise.
So we are left with good old macroeconomic policy. I did not change my mind since my latest piece on the ECB. Even if the ECB inertia is appalling, even if their stubbornness in claiming that everything is fine (see above) is more than annoying, even if announcing mild QE measures in 2015 at the earliest is borderline criminal, it remains that I have no big faith in the capacity of monetary policy to trigger decent growth. The latest issue of the ECB bulletin also reports the results of the latest Eurozone Bank Lending Survey. They show a slow easing of credit conditions, that proceed in parallel with a pickup of credit demand from firms and households. While for some countries credit constraints may play a role in keeping private expenditure down (for example, in Italy), the overall picture for the EMU is of demand and supply proceeding in parallel. Lifting constraints to lending, in this situation, does not seem likely to boost credit and spending. It’s the liquidity trap, stupid!
The solution seems to be one, and only one: expansionary fiscal policy, meaning strong increase in government expenditure (above all for investment) in countries that can afford it (Germany, to begin with); and delayed consolidation for countries with struggling public finances. Monetary policy should accompany this fiscal boost with the commitment to maintain an expansionary stance until inflation has overshot the 2% target.
For the moment this remains a mid-summer dream…
I am puzzled by Wolfgang Münchau’s latest piece in the Financial Times. Let me start by quoting the end:
[...] The ECB should have started large-scale asset purchase a year ago. It certainly should do so now. The EU should allow governments to overshoot their deficit targets this year, and suspend the fiscal compact, which will result in further fiscal pain from 2016.
Even a casual reader of this blog will quickly realize that it would be hard for me to agree more with these statements. The macroeconomic stance at the EMU level has been seriously inappropriate since 2010, with fiscal policy globally restrictive (thank you austerity), and monetary policy way too timid.
So, what is the problem? The problem is the first part of Münchau’s editorial, in which he attacks the Bundesbank for its plea in favour of faster wage growth in Germany (the Buba asked for an average wage increase of 3%).
This is frankly hard to understand. The eurozone problems, and it’s flirting with deflation, stem from the victory of the Berlin View, that laid the burden of adjustment on the shoulders of peripheral countries alone.
The call for wage increases in Germany signals, and it was about time, that even conservative German institutions are beginning to realize the obvious: there will be no rebalancing, and therefore no robust recovery, unless German domestic demand recovers. This means a fiscal expansion, as well as private expenditure recovery. Unsurprisingly, the Buba rules out the former, but it is nice to see that at least the latter has become an objective. Faster wage growth may not make a huge difference in quantitative terms, but it still marks an important change of attitude. This is a huge step away from the low-wage-high-productivity-export-led model that the Bundesbank and the German government have been preaching (and imposing to their partners).
Münchau is right in calling for a different policy mix in the EMU. But this is complementary, not alternative, to a change in the German growth model. I would have expected him to applaud a small but potentially important change in attitude. Instead I have read a virulent attack. Puzzled, puzzled…
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…
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:
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.
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?
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.
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
Today we learn from Daniel Gros, on Project Syndicate that the emphasis on German surplus is misplaced:
The discussion of the German surplus thus confuses the issues in two ways. First, though the German economy and its surplus loom large in the context of Europe, an adjustment by Germany alone would benefit the eurozone periphery rather little. Second, in the global context, adjustment by Germany alone would benefit many countries only a little, while other surplus countries would benefit disproportionally. Adjustment by all northern European countries would have double the impact of any expansion of demand by Germany alone, owing to the high degree of integration among the “Teutonic” countries.
Fascinating. The bulk of the argument is that Germany is a small player in the global economy, and therefore that its actions have no impact. I have two objections to Gros’ argument. Read More