Archive for the ‘Global Imbalances’ Category

Blame the World?

August 15, 2014 12 comments

Yesterday’s headlines were all for Germany’s poor performance in the second quarter of 2014 (GDP shrank of 0.2%, worse than expected). That was certainly bad news, even if in my opinion the real bad news are hidden in the latest ECB bulletin, also released yesterday (but this will be the subject of another post).

Not surprisingly, the German slowdown stirred heated discussion. In particular Sigmar Gabriel, Germany’s vice-chancellor, blamed the slowdown on geopolitical risks in eastern Europe and the Near East. Maybe he meant to be reassuring, but in fact his statement should make us all worry even more. Let me quote myself (ach!), from last November:

Even abstracting from the harmful effects of austerity (more here), the German model cannot work for two reasons: The first is the many times recalled fallacy of composition): Not everybody can export at the same time. The second, more political, is that by betting on an export-led growth model Germany and Europe will be forced to rely on somebody else’s growth to ensure their prosperity. It is now U.S. imports; it may be China’s tomorrow, and who know who the day after tomorrow. This is of course a source of economic fragility, but also of irrelevance on the political arena, where influence goes hand in hand with economic power. Choosing the German economic model Europe would condemn itself to a secondary role.

I have emphasized the point I want to stress, once again, here: adopting an export-led model structurally weakens a country, that becomes unable to find, domestically, the resources for sustainable and robust growth. And here we are, the rest of the world sneezes, and Germany catches a cold. The problem is that we are catching it together with Germany:


The ratio of German GDP over domestic demand has been growing steadily since 1999 (only in 19 quarters out of 72, barely a third, domestic demand grew faster than GDP). And what is more bothersome is that since 2010 the same model has been  adopted by imposed to the rest of the eurozone. The red line shows the same ratio for the remaining 11 original members of the EMU, that was at around one for most of the period, and turned frankly positive with the crisis and implementation of austerity.It is the Berlin View at work, brilliantly and scaringly exposed by Bundesbank President Jens Weidmann just a couple of days ago. We are therefore increasingly dependent on the rest of the world for our (scarce) growth (the difference between the ratio and 1 is the current account balance).

It is easy today to blame Putin, or China, or tapering, or alien invasions, for our woes.  Easy but wrong. Our pain is self-inflicted. Time to change.

Wanted: German Inflation

March 6, 2014 8 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

Fiscal Expansion or What?

January 21, 2014 4 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?

Reduce Inequality to Fight Secular Stagnation

December 22, 2013 9 comments

Larry Summers’ IMF speech on secular stagnation partially shifted the attention from the crisis to the long run challenges facing advanced economies. I like to think of Summers’ point of as a conjectures that “in the long run we are all Keynesians”, as we face a permanent shortage of demand that may lead to a new normal made of hard choices between an unstable, debt-driven growth, and a quasi-depressed economy. A number of factors, from aging and demographics to slowing technical progress, may support the conjecture that globally we may be facing permanently higher levels of savings and lower levels of investment, leading to negative natural rates of interest. Surprisingly, another factor that had a major impact in the long-run compression of aggregate demand has been so far neglected: the steep and widespread increase of inequality. Reversing the trend towards increasing inequality would then become a crucial element in trying to escape secular stagnation.
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Competitive Structural Reforms

December 16, 2013 4 comments

Mario Draghi, in an interview to the Journal du Dimanche, offers an interesting snapshot of his mindset.  He (correctly in my opinion) dismisses euro exit and competitive devaluations as a viable policy choices:

The populist argument that, by leaving the euro, a national economy will instantly benefit from a competitive devaluation, as it did in the good old days, does not hold water. If everybody tries to devalue their currency, nobody benefits.

But in the same (short) interview, he also argues that

We remain just as determined today to ensure price stability and safeguard the integrity of the euro. But the ECB cannot do it all alone. We will not do governments’ work for them. It is up to them to undertake fundamental reforms, support innovation and manage public spending – in short, to come up with new models for growth. […] Taking the example of German growth, that has not come from the reduction of our interest rates (although that will have helped), but rather from the reforms of previous years.

I find it fascinating: Draghi manages to omit that German increased competitiveness mostly came from wage restraint and domestic demand compression, as showed by a current account that went from a deficit to a large surplus over the past decade.  Compression of domestic demand and export-led growth, in the current non-cooperative framework, would mean taking market shares from EMU partners. This is in fact what Germany did so far, and is precisely the same mechanism we saw at work in the 1930s. Wages and prices would today take the place of exchange rates then, but the mechanism, and the likely outcome are the same. Unless…

Draghi probably has in mind a process by which all EMU countries embrace the German export-led model, and export towards the rest of the world. I have already said (here, here, and here) what I think of that.  We are not a small open economy. If we depress our economy there is only so much the rest of the world can do to lift it through exports. And it remains that the second largest economy in the world deserves better than being a parasite on the shoulders of others…

As long as German economists are like the guy I met on TV last week, there is little to be optimist about…