My Grain of Salt on Brexit and on the Risk of XXxit

June 24, 2016 7 comments

Much has been said, already, and even more will be said in the coming hours/days/weeks/months/years, on Brexit. I have little to add. So here is what I see as a series of notes to self. For those who are already tired of reading pages and pages, I can summarize what follows in a sentence: We should focus more on policies than on institutions

  1. The long lasting skepticism about the EU that always permeated British society across the board, has eventually been compounded by the recent dreadful performance of EU member states in managing the crises that have hit our communities. A sparse and incomplete list would include the stubborn insistence on the wrong policy mix (austerity cum reforms) which yielded a double-dip recession that no other large economy experienced in the past decade; the obsession with debt and deficits when the economy was in desperate need for public support to aggregate demand; the despise of democracy shown when dealing with the Greek referendum last summer; the slow moving ECB that only took action years (not weeks, years) after the other central banks; the bullying of small countries in crisis, in negotiations that really were not one, but rather a take-it-or-leave-it; and finally, maybe the mother of all policy mistakes, the cynical and illogical management of refugees crisis. Show that to voters who always were half in and half out, and it is no surprise that they want to walk away.
  2. The EU has been made the scapegoat for choices of the UK government, that was reelected just a few months ago. Osborne and Cameron embraced austerity and government downsizing wholeheartedly, they did not need the EU for this. If it is these policies that the British voters wanted to sanction, then they cast their vote in the wrong elections.
  3. Which brings me to those who today happily see Brexit as the beginning of the end of the EU, and with it of austerity and reforms. I am afraid they are delusional here. Neoliberal policies existed before the EU, and they will exist after. They are the making of governments (and academics), that will not vanish together with the EU. Rather the contrary. Let’s not forget that one of the main selling points of the Leave camp has been that EU regulation chokes UK businesses. If you want to scrap neoliberal policies, rather than fighting the EU, that is a mere vehicle, you should fight the governments that propose them . Remind me of that old story about looking at the finger rather than at the moon?
  4. My feeling is, and I am afraid to be proven right, that the disintegration of the EU would make it harder to protect social justice, workers’ right, the welfare state. Small countries would be even more exposed than the EU as a whole to competitive pressure from the rest of the world. And competitive pressure in the past never turned out to work in favour of labour and wages.
  5. The fact that neoliberalism has very little to do with the EU is proven by the rise of populism well beyond our borders. The global problem is an increasingly dysfunctional economic system. If you kill growth and prosperity, if you increase the social divide, if you boost inequality, then it is no surprise that the first guy saying “life was better before” is given a chance by voters. In normal times, a somebody like Farage (or Le Pen, or Trump, or Salvini) would have very little traction with the voters. Today they give the cards of the political game. And in Europe the game is made easier by the existence of a perfect scapegoat, that is far and immaterial, the EU.
  6. This is why I would also resist the temptation to blame the voters as irresponsible, conservative, irrational, nostalgic, uneducated. The age or education divide of the Brexit referendum is all over the web. But I see them both as proxies for the really relevant divide, which is between the winners and the losers of the past few decades. The same divide that emerges in the US (where paradoxically the losers put faith in the typical winner), and in all the other EU countries.
  7. How to win the hearths and minds of the losers? How to claim their confidence back? Should that not be by definition the essence of a progressive agenda? The way out is to end harmful policies, and to re-transform the EU into a symbol of social progress. Easier said than done, of course; but I see no alternative. What I have been writing in this blog since 2011 tries to explore possible ways to do so. We should stop looking at institutions (the Stability Pact, the euro), and focus on policies, fighting the wrong ones and supporting the right ones. EU institutions are certainly dysfunctional. They are certainly biased towards excessive reliance on market mechanisms (that prove over and over again how far they are from the academic ideal of perfect efficiency). But once again, they can be twisted, and even changed, if only a political will to do so emerges. In a sentence, even within the current institutional framework, if there was a clear political consensus towards abandoning austerity, we could do so. The problem, I will never get tired of repeating it, is not the Stability Pact. The problem are governments that fail to put it on hold or even to change it.
  8. (This is just a sharper restatement of 4). We should stop fighting the EU (or the euro) as the cause of our troubles. We should spot the forces that within each country fight for a radical change in policies, and work to give them a majority. If we do so, the EU will cease to be a problem, and will hopefully become again a force of progress. If we don’t, no Brexit or XXxit will bring to us prosperity. Rather the contrary.
  9. Of course I am thinking in particular of large countries. The Syriza experience in Greece proves that “rejection of austerity in a single country”, especially if it is small and in trouble, cannot work. A new paradigm for policy making should emerge in France, in Germany, in Italy. That would allow a meaningful debate at the European scale.
  10. All this said, given how self-referential are our elites, how self-indulgent, how superficial in their approach to policy, my “gloominess” is doomed to persist.

Pushing on a String

June 3, 2016 Leave a comment

Readers of this blog know that I have been skeptical on the ECB quantitative easing program.
I said many times that the eurozone economy is in a liquidity trap, and that making credit cheaper and more abundant would not be a game changer. Better than nothing, (especially for its impact on the exchange rate, the untold objective of the ECB), but certainly not a game changer.
The reason, is quite obvious. No matter how cheap credit is, if there is no demand for it from consumers and firms, the huge liquidity injections of the ECB will end up inflating some asset bubble. Trying to boost economic activity (and inflation) with QE is tantamount to pushing  on a string.

I also said many times that without robust expansionary fiscal policy, recovery will at best be modest.

Two very recent ECB surveys provide strong evidence in favour of the liquidity trap narrative. The first is the latest (April 2016) Eurozone Bank Lending Survey. Here is a quote from the press release:

The net easing of banks’ overall terms and conditions on new loans continued for loans to enterprises and intensified for housing loans and consumer credit, mainly driven by a further narrowing of loan margins.

So, nothing surprising here. QE and negative rates are making so expensive for financial institutions to hold liquidity, that credit conditions keep easing.
So why do we not see economic activity and inflation pick up? The answer is on the other side of the market, credit demand. And the Survey on the Access to Finance of Enterprises in the euro area, published this week  also by the ECB, provides a clear and loud answer (from p. 10):

“Finding customers” was the dominant concern for euro area SMEs in this survey period, with 27% of euro area SMEs mentioning this as their main problem, up from 25% in the previous survey round. “Access to finance” was considered the least important concern (10%, down from 11%), after “Regulation”, “Competition” and “Cost of production” (all 14%) and “Availability of skilled labour” (17%). Among SMEs, access to finance was a more important problem for micro enterprises (12%). For large enterprises, “Finding customers” (28%) was reported as the dominant concern, followed by “Availability of skilled labour” (18%) and “Competition” (17%). “Access to finance” was mentioned less frequently as an important problem for large firms (7%, unchanged from the previous round)

No need to comment, right?

Just a final and quick remark, that in my opinion deserves to be developed further: finding skilled labour seems to become harder in European countries. What if these were the first signs of a deterioration of our stock of “human capital” (horrible expression), after eight years of crisis that have reduced training, skill building, etc.?
When sooner or later the crisis will really be over, it will be worth keeping an eye on  “Availability of skilled labour” for quite some time.

Tell me again that story about structural reforms enhancing potential growth?

On the Importance of Fiscal Policy

May 2, 2016 3 comments

Last week’s data on EMU growth have triggered quite a bit of comments. I was intrigued by Paul Krugman‘s piece arguing (a) that in per capita terms the EMU performance is not as bad (he uses working age population, I used total population); and (b) that the path of the EMU was similar to that of the US in the first phase of the crisis; and (c) that divergence started only in 2011, due to differences in monetary policy (an impeccable disaster here, much more reactive in the US). Fiscal policy, Krugman argues, was equally contractionary across the ocean.
I pretty much agree that the early policy response to the crisis was similar, and that divergence started only when the global crisis went European, after the Greek elections of October 2009. But I am puzzled (and it does not happen very often) by Krugman’s dismissal of austerity as a factor explaining different performances. True, at first sight, fiscal consolidation kicked in at the same moment in the US and in Europe. I computed the fiscal impulse, using changes in the cyclically adjusted primary deficit. In other words, by taking away the cyclical component, and interest payment, we can obtain the closest possible measure to the discretionary fiscal stance of a government. And here is what it gives:
2016_05_02_ImportanceFiscalPolicy_1
Krugman is certainly right that austerity was widespread in 2011 and in 2012 (actually more in the US). So what is the problem?
The problem is that fiscal consolidation needs not to be assessed in isolation, but in relation to the environment in which it takes place. First, it started one year earlier in the EMU (look at the bars for 2010). Second, expansion had been more robust in the US in 2008 and in 2009, thus avoiding that the economy slid too much: having been bolder and more effective in 2008-2010, continued fiscal expansion was less necessary in 2011-12.
I remember Krugman arguing at the time that the recovery would have been stronger and faster if the fiscal stance in the US had remained expansionary. I agreed then and I agree now: government support to the economy was withdrawn when the private sector was only partially in condition to take the witness. But to me it is just a question of degree and of timing in reversing a fiscal policy stance that overall had been effective.
I had made the same point back in 2013. Here is, updated from that post, the correlation between public and private expenditure:

Correlation Between Public and Private Expenditure
2008-2009 2010-2012 2013-2015
EMU -0.96 0.73 0.99
USA -0.82 -0.96 -0.04

Remember, a positive correlation means that fiscal policy moves together with private expenditure, and fails to act countercyclically. The table tells us that public expenditure in the US was withdrawn only when private expenditure could take the witness, and never was procylclical (it turned neutral in the past 2 years). Europe is a whole different story. Fiscal contraction began when the private sector was not ready to take the witness; the withdrawal of public demand therefore led to a plunge in economic activity and to the double dip recession that the US did not experience. Here is the figure from the same post, also updated:
2016_05_02_ImportanceFiscalPolicy_2
To sum up: the fiscal stance in the US was appropriate, even if it changed a bit too hastily in 2011. In Europe, it was harmful since 2010.

And monetary policy in all this? It did not help in Europe. I join Krugman in believing that once the economy was comfortably installed in the liquidity trap Mario Draghi’s activism while necessary was (and is)  far from sufficient. Being more timely, the Fed played an important role with its aggressive monetary policy, that started precisely in 2012. It supported the expansion of private demand, and minimized the risk of a reversal when the withdrawal of fiscal policy begun. But in both cases I am unsure that monetary policy could have made a difference without fiscal policy. Let’s not forget that a first round of aggressive monetary easing in 2007-2008 had been successful in keeping the financial sector afloat, but not in avoiding the recession. This is why in 2009 most economies launched robust fiscal stimulus plans. I see no reason to believe that, in 2010-2012, more appropriate and timely ECB action would have made a big difference. The problem is fiscal, fiscal, fiscal.

Celebrate

April 29, 2016 13 comments

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:
2016_04_29_Compare

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:
2016_04_29_Compare_1
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?

The Sin of Central Bankers

April 19, 2016 Leave a comment

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…

 

Convergence no More

April 14, 2016 Leave a comment

As a complement to the latest post, here is a quite eloquent figure

2016_04_Convergence_no_More

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.

Resilience? Not Yet

April 11, 2016 1 comment

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.