Posts Tagged ‘EMU Crisis’

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!!


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

What is Wrong with the EU?

December 5, 2013 4 comments

Eurostat just released the 2012 figures for poverty and social exclusion in the EU. The numbers are terrifying. Let me quote the press release: “In 2012, 124.5 million people, or 24.8% of the population, in the EU were at risk of poverty or social exclusion,  compared with 24.3% in 2011 and 23.7% in 2008. This means that they were in at least one of the following three conditions: at-risk-of-poverty, severely materially deprived or living in households with very low work intensity
One may be tempted to shrug. After all, 1% in four years, is not that much. Let me put actual people behind the numbers: The number of people at risk of poverty increased of 5.5 millions between 2008 and 2012. Strikingly, always looking at Eurostat data, the number of jobs lost in the EU28 over the same period is almost exactly the same (-5.4 millions).

This is plain unacceptable. And teaches us two lessons

  • Our welfare system is not capable anymore to shield workers from the hardship of business cycles. We progressively dismantled welfare, becoming “more like the United States”. But we stubbornly refuse to accept the consequence of this, i.e. that fiscal and monetary policy need (like in the US) to be proactive and flexible, so as to dampen the cycle. Constraints to macroeconomic policy, coupled with a diminished protection from the welfare state, spell disaster, social exclusion, and the destruction of the social fabric.
  • The second lesson is that these numbers are there to stay. The economy may recover, but the loss of confidence, of capacity, of social status of those who we pushed into hardship, will stay with us for years to come. We are destroying human capital at amazing speed.

What is enraging is that none of this was inevitable. The crisis could have been shielded by less ideological leadership in European institutions and in some most European capitals. Frontloading of austerity in the periphery was a terrible mistake. Not accompanying it with fiscal expansion in the core was a crime, showing of how little solidarity counts, facing the protestant urge to “punish the sinners”.

The result is that one of the most affluent economic areas of the world barely notices that one quarter of its population lives at risk of poverty. What is wrong with us?

Of Actions and Words in Frankfurt

November 12, 2013 Leave a comment

Last Thursday the ECB cut rates, somewhat unexpectedly. This shows that it takes the risk of deflation very seriously. Good news, I’d say. But unfortunately, press conferences follow ECB Council meetings. And I say unfortunately, because Mr Draghi words often fail to match his actions. Here is what he said on Thursday (I could not resist adding some bold here and there):

If you look at the euro area from a distance, you see that the fundamentals in this area are probably the strongest in the world. This is the area that has the lowest budget deficit in the world. Our aggregate public deficit is actually a small surplus. We have a small primary surplus of 0.7%, compared with, I think, a deficit of 6 or 7% deficit in US, – 6 I think – and 8 % in Japan. This is the area with the highest current account surplus. And it is also the area, as we said before, with one of the lowest – if not the lowest – inflation rate.

Fascinating. Truly fascinating. I will pass on the fact that one of the strong “fundamentals” Mr Draghi quotes, low inflation, is actually the main source of worry for economists and policymakers worldwide, including the ECB, that had to rush into a rate cut that was not planned at least until December! I will also pass on his praise of high current account surpluses while the Commission itself is considering opening an infraction procedure against Germany, for perpetuating an important source of imbalances within the eurozone and worldwide.

No, what I find more shocking is the list of fundamentals Draghi gives: public debt and deficit; inflation; current account balance. Now, it dates back a little, but I remember all of those, in Econ 101, to be defined as instruments of economic policy, supposed to serve the final objectives of growth and employment. It is true that we do rather well in what Draghi calls fundamentals, but I continue preferring to call instruments. Look at this table:

I have reported, for ease of comparison, data from the IMF World Economic Outlook (October 2013), therefore they are not the latest (quarterly or monthly) data. Also, I have highlighted in red the worst performer, and in green the best. And boy, Draghi is right! (Notice incidentally that eurozone inflation was 2.5 percent on average in 2012. With the latest data at 0.7 percent, this suggests that  we are running, not walking, towards deflation.)

But if we look at the supposed objectives of economic policy (how would Draghi call these?), the picture changes, quite a bit:


No other major advanced economy is doing nearly as badly as the eurozone in terms of unemployment and GDP. But according to the ECB President we have “the strongest fundamentals in the world”. Does this means that Draghi did not take Econ 101? No, I know for sure that he did take it, and  he actually had excellent mentors. To understand Draghi’s claim, it may be useful to read his whole sentence. After arguing that the eurozone has strong fundamentals he goes on:

This does not translate automatically into a galloping recovery. But, actually, it gives you the fundamentals upon which you can pursue the right economic policies. Structural reforms are the necessary and sufficient condition for this to happen. In the absence of that, unfortunately, we are going to stay here for quite a long time.

Here is the answer. The only and one answer. Focusing on instruments instead of targets is the strategy of those who do not believe that a role exists for active economic policies. It is a pity that one of these guys is heading the second most important central bank of the world. And it is paradoxically reassuring that the situation is currently so bad that he is forced to abandon his creed and implement active monetary policies.

Advice for the next episodes: praise Mario Draghi actions, and avoid reading the transcripts of his press conferences.

Look who’s Gloomy

October 28, 2013 2 comments

Wolfgang Munchau has an excellent piece on today’s Financial Times, where he challenges the increasingly widespread (and unjustified) optimism about the end of the EMU crisis. The premise of the piece is that for the end of the crisis to be durable, it must pass through adjustment between core and periphery. He cites similar statements made in the latest IMF World Economic Outlook. This is good news per se, because nowadays, with the exception of Germany it became common knowledge that the EMU imbalances are structural and not simply the product of late night parties in the periphery. But what are Munchau’s reasons for pessimism? Read More