Stronger than expected GDP growth in France and Spain (0.5% and 0.8% in 2016Q1, 0.1% more than expected!) has boosted Eurozone GDP to a staggering +0.6% in the first quarter of 2016. The Financial Times notes that GDP is now above its pre-crisis level. I expect, in the next few days, celebrations in some quarters.
So, just a reminder:
The figure speaks for itself. While we had a lost decade (eight-ade), The US and the OECD as a whole were out of the woods in 2011Q2. Our neighbours across the Channel in 2013Q2. Furthermore, we were the only ones to go through a double dip recession, and are the only ones still fighting with deflationary pressures.
Of course, if we look at per capita GDP (warning, I constructed it myself, simply dividing real GDP by population on January 1st), the lost decade may materialize after all:
I added Greece as a second reminder. The country is back at case one, in yet another round of difficult negotiations. And I do believe that remembering what they have endured may help
So, tell me again, what should we be celebrating?
I read, a bit late, a very interesting piece by Simon Wren-Lewis, who blames central bankers for three major mistakes: (1) They did not see the crisis coming, while they were the only one in the position to see the build-up of leverage; (2) They did not warn governments that at the Zero Lower Bound central banks would lose traction and could not protect the economy from the disasters of austerity. (3) They may be rushing in declaring that we are back to normal, thus attributing all the current slack to a deterioration of the supply side of the economy.
What surprises me is (2), for which I quote Wren-Lewis in full:
Of course the main culprit for the slow recovery from the Great Recession was austerity, by which I mean premature fiscal consolidation. But the slow recovery also reflects a failure of monetary policy. In my view the biggest failure occurred very early on in the recession. Monetary policy makers should have said very clearly, both to politicians and to the public, that with interest rates at their lower bound they could no longer do their job effectively, and that fiscal stimulus would have helped them do that job. Central banks might have had the power to prevent austerity happening, but they failed to use it.
The way Wren-Lewis writes it, central banks were not involved in the push towards fiscal consolidation, and their “only” sin was of not being vocal enough. I think he is too nice. At least in the Eurozone, the ECB was a key actor in pushing austerity. It was directly involved in the Trojka designing the rescue packages that sunk Greece (and the EMU with it). But more importantly, the ECB contributed to design and impose the Berlin View narrative that fiscal profligacy was at the roots of the crisis, so that rebalancing would have to be on the shoulders of fiscal sinners alone. We should not forget that “impeccable disaster” Jean-Claude Trichet was one of the main supporters of the confidence fairy: credible austerity would magically lift expectations, pushing private expenditure and triggering the recovery. He was the President of the ECB when central banks made the second mistake. And I really have a hard time picturing him warning against the risks of austerity at the zero lower bound.
And things are not drastically different now. True, Mario Draghi often calls for fiscal support to the ECB quantitative easing program. But as I argued at length, calling for fiscal policy within the existing rules’ framework has no real impact.
So I disagree with Wren-Lewis on this one. Central banks, or at least the ECB, did not simply fail to contrast the problem of wrongheaded austerity. They were, and may still be, part of the problem.
The problem is one of economic doctrine. And as long as this does not change, I am unsure that removing central bank independence would have made a difference. Would a Bank of England controlled by Chancellor Osborne have been more vocal against austerity? Would an ECB controlled by the Ecofin? Nothing is less sure…
As a complement to the latest post, here is a quite eloquent figure
I computed real GDP of the periphery (Spain-Ireland-Portugal-Greece) and of the core (Germany-Netherlands-Austria-Finland), and then I took the difference of yearly growth rates in three subperiods that correspond to the run-up to the single currency, to the euro “normal times”, and to the crisis.
Let’s focus on the red bar: until 2008 the periphery on average grew more than 1% faster than the core, a difference that was even larger during the debt (private and public) frenzy of the years 2000. Was that a problem? No. Convergence, or catch-up, is a standard feature of growth. Usually (but remember, exceptions are the rule in economics), poorer economies tend to grow faster because there are more opportunities for high productivity growth. So it is not inconceivable that growth in the periphery was consistently higher than in the core especially in a phase of increasing trade and financial integration;
We all know (now; and some knew even then) that this was unhealthy because imbalances were building up, which eventually led to the crisis. But it is important to realize that the problem were the imbalances, not necessarily faster growth. In fact, if we look at the yellow bar depicting the difference in potential growth, it shows the same pattern (I know, the concept of potential growth is unreliable. But hey, if it underlies fiscal rules, I have the right to graph it, right?).
During the crisis the periphery suffered more than the core, and its potential output grew less
fell more. This is magnified by the mechanic effect of current growth that “pulls” potential output. But it is undeniable that the productive capacity of the periphery (capital, skills) has been dented by the crisis, much more so than in the core. Thus, not only we are collectively more fragile, as I noted last Monday;on top of that, the next shock will hurt the periphery more than the core, further deepening the divide.
The EMU in its current design lacks mechanisms capable of neutralizing pressure towards divergence. It was believed when the Maastricht Treaty was signed that markets alone would ensure convergence. It turns out (unsurprisingly, if you ask me) that markets not only did not ensure convergence. But they were actually a powerful force of divergence, first contributing to the buildup of imbalances, then by fleeing the periphery when trouble started.
Markets do not act as shock absorbers. It is as simple as that, really.
Last week the ECB published its Annual Report, that not surprisingly tells us that everything is fine. Quantitative easing is working just fine (this is why on March 10 the ECB took out the atomic bomb), confidence is resuming, and the recovery is under way. In other words, apparently, an official self congratulatory EU document with little interest but for the data it collects.
Except, that in the foreword, president Mario Draghi used a sentence that has been noticed by commentators, obscuring, in the media and in social networks, the rest of the report. I quote the entire paragraph, but the important part is highlighted
2016 will be a no less challenging year for the ECB. We face uncertainty about the outlook for the global economy. We face continued disinflationary forces. And we face questions about the direction of Europe and its resilience to new shocks. In that environment, our commitment to our mandate will continue to be an anchor of confidence for the people of Europe.
Why is that important? Because until now, a really optimistic and somewhat naive observer could have believed that, even amid terrible sufferings and widespread problems, Europe was walking the right path. True, we have had a double-dip recession, while the rest of the world was recovering. True, the Eurozone is barely at its pre-crisis GDP level, and some members are well below it. True, the crisis has disrupted trust among EU countries and governments, and transformed “solidarity” into a bad word in the mouth of a handful of extremists. But, one could have believed, all of this was a necessary painful transition to a wonderful world of healed economies and shared prosperity: No gain without pain. And the naive observer was told, for 7 years, that pain was almost over, while growth was about to resume, “next year”. Reforms were being implemented (too slowly, ça va sans dire) , and would soon bear fruits. Austerity’s recessionary impact had maybe been underestimated, but it remained a necessary temporary adjustment. The result, the naive observer would believe, would eventually be that the Eurozone would grow out of the crisis stronger, more homogeneous, and more competitive.
I had noticed a long time ago that the short term pain was evolving in more pain, and more importantly, that the EMU was becoming more heterogeneous precisely along the dimension, competitiveness, that reforms were supposed to improve. I also had noticed that as a result the Eurozone would eventually emerge from the crisis weaker, not stronger. More rigorous analysis ( e.g. here, and here) has recently shown that the current policies followed in Europe are hampering the long term potential of the economy.
Today, the ECB recognizes that “we face questions about the resilience [of Europe] to new shocks”. Even if the subsequent pages call for more of the same, that simple sentence is an implicit and yet powerful recognition that more of the same is what is killing us. Seven years of treatment made us less resilient. Because, I would like to point out, we are less homogeneous than we were in 2007. A hard blow for the naive observer.
Yesterday I was asked by the Italian weekly pagina99 to write a comment on the latest ECB announcement. Here is a slightly expanded English version.
Mario Draghi had no choice. The increasingly precarious macroeconomic situation, deflation that stubbornly persists, and financial markets that happily cruise from one nervous breakdown to another, had cornered the ECB. It could not, it simply could not, risk to fall short of expectations as it had happened last December. And markets have not been disappointed. The ECB stored the bazooka and pulled out of the atomic bomb. At the press conference Mario Draghi announced 6 sets of measures (I copy and paste):
- The interest rate on the main refinancing operations of the Eurosystem will be decreased by 5 basis points to 0.00%, starting from the operation to be settled on 16 March 2016.
- The interest rate on the marginal lending facility will be decreased by 5 basis points to 0.25%, with effect from 16 March 2016.
- The interest rate on the deposit facility will be decreased by 10 basis points to -0.40%, with effect from 16 March 2016.
- The monthly purchases under the asset purchase programme will be expanded to €80 billion starting in April.
- Investment grade euro-denominated bonds issued by non-bank corporations established in the euro area will be included in the list of assets that are eligible for regular purchases.
- A new series of four targeted longer-term refinancing operations (TLTRO II), each with a maturity of four years, will be launched, starting in June 2016. Borrowing conditions in these operations can be as low as the interest rate on the deposit facility.
Items 1-3 depict a further decrease of interest rates. Answering a question Mario Draghi hinted that rates will be lower for a long period, but also that this may be the lower bound (sending markets in an immediate tailspin; talk of rational, well thought decisions). The “tax” the ECB imposes on excess reserves, the liquidity that financial institutions keep idle, is now at -0,4%. Not insignificant.
But the real game changer are the subsequent items, that really represent an innovation. Items 4-5 announce an acceleration of the bond buying program, and more importantly its extension to non-financial corporations, which changes its very nature. In fact, the purchase of non-financial corporations’ securities makes the ECB a direct provider of funding for the real sector. With these quasi-fiscal operations the ECB has therefore taken a step towards what economists call “helicopter money”, i.e. the direct financing of the economy cutting the middlemen of the financial and banking sector.
Finally, item 6, a new series of long-term loan programs, with the important innovation that financial institutions which lend the money to the real sector will obtain negative rates, i.e. a subsidy. This measure is intended to lift the burden for banks of the negative rates on reserves, at the same time forcing them to grant credit: The banks will be “paid” to borrow, and then will make a profit as long as they place the money in government bonds or lend to the private sector, even at zero interest rates.
To summarize, it is impossible for the ECB to do more to push financial institutions to increase the supply of credit. Unfortunately, however, this does not mean that credit will increase and the economy rebound. There is debate among economists about why quantitative easing has not worked so far. I am among those who think that the anemic eurozone credit market can be explained both by insufficient demand and supply. If credit supply increases, but it is not followed by demand, then today’s atomic bomb will evolve into a water gun. With the added complication that financial institutions that fail to lend, will be forced to pay a fee on excess reserves.
But maybe, this “swim or sink” situation is the most positive aspect of yesterday’s announcement. If the new measures will prove to be ineffective like the ones that preceded them, it will be clear, once and for all, that monetary policy can not get us out of the doldrums, thus depriving governments (and the European institutions) of their alibi. It will be clear that only a large and coordinated fiscal stimulus can revive the European economy. Only time will tell whether the ECB has the atomic bomb or the water gun (I am afraid I know where I would place my bet). In the meantime, the malicious reader could have fun calculating: (a) How many months of QE would be needed to cover the euro 350 billion Juncker Plan, that painfully saw the light after eight years of crisis, and that, predictably, is even more painfully being implemented. (b) How many hours of QE would be needed to cover the 700 million euros that the EU, also very painfully, agreed to give Greece, to deal with the refugee influx.
FT Alphaville‘s Matthew Klein goes back to the issue of financial stability and monetary policy. A recent speech of Bank of Canada’s Timothy Lane is the occasion for Klein to reassess monetary policy before the crisis, when policy makers (in particular he refers to Ben Bernanke, but the Fed chair was in good company) dismissed fears of asset price bubbles, thus failing recognize, and to counter, the buildup of the crisis.
What I find interesting in Lane’s speech is the acknowledgement that monetary policy alone is vastly insufficient to attain the many interrelated objectives of today’s policy makers. This in turn calls for reassessing the drift of academic economists (in the 1990s and 2000s) towards a vision of the world in which all policy objectives could be attained by “Maestros“, almighty technocrats skillfully using monetary levers to reach multiple objectives at once.
With a few colleagues we recently challenged the “conventional wisdom” that inflation targeting central banks can effectively attain financial stability as well, simply by “leaning against the wind”. We highlighted that this violation of Timbergen’s principle (“one instrument per policy objective”) is allowed by an analytical trick, a “divine coincidence”, buried within the hypotheses of the standard model. Asessing policy analysis in a framework in which low and stable inflation goes hand in hand with low unemployment and stable asset prices, will lead to conclude that (what a surprise!!) targeting inflation helps attaining all these objectives at once. Our work (among others) shows that price and financial stability exhibit no stable correlation; similarly, the debate on the “return of the Phillips Curve” (if ever it left) shows that a tradeoff usually exists between inflation and unemployment objectives. Thus, in the end, inflation targeting is mostly effective in, well… targeting inflation. There is no magics here. The Consensus buried Timbergen way too soon.
The debate on the effective use of instruments to attain sometimes conflicting objectives is particularly interesting in general and, I argue, relevant for the EMU. As the readers of this blog know, I have been obsessed by the excessive focus of (mainly) European economists and policy makers on monetary policy. Especially in the current situation of liquidity trap, the stubborn refusal to fully deploy fiscal policy can only be explained by ideological anti-Keynesianism.
But as Timothy Lane’s speech suggests, the problem extends beyond the current exceptional circumstances. As normal times will (eventually) resume, we should go back to Timbergen and acknowledge that monetary policy alone cannot cure all ills. Fiscal policy and effective regulation need to be used as aggressively as interest rates and monetary instruments to manage business cycle fluctuation. A trivial and yet often forgotten lesson from the old times.