Posts Tagged ‘EMU Crisis’

Draghi the Fiscal Hawk

October 23, 2015 4 comments

We are becoming accustomed to European policy makers’ schizophrenia, so when yesterday during his press conference Mario Draghi mentioned the consolidating recovery while announcing further easing in December, nobody winced. Draghi’s call for expansionary fiscal policies was instead noticed, and appreciated. I suggest some caution. Let’s look at Draghi’s words:

Fiscal policies should support the economic recovery, while remaining in compliance with the EU’s fiscal rules. Full and consistent implementation of the Stability and Growth Pact is crucial for confidence in our fiscal framework. At the same time, all countries should strive for a growth-friendly composition of fiscal policies.

During the Q&A, the first question was on precisely this point:

Question: If I could ask you to develop the last point that you made. Governor Nowotny last week said that monetary policy may be coming up to its limits and perhaps it was up to fiscal policy to loosen a little bit to provide a bit of accommodation. Could you share your thoughts on this and perhaps even touch on the Italian budget?

(Here is the link to  Austrian Central Bank Governor Nowotny making a strong statement in favour of expansionary fiscal policy). Draghi simply did not answer on fiscal policy (nor on the Italian budget, by the way). The quote is long but worth reading

Draghi: On the first issue, I’m really commenting only on monetary policy, and as we said in the last part of the introductory statement, monetary policy shouldn’t be the only game in town, but this can be viewed in a variety of ways, one of which is the way in which our colleague actually explored in examining the situation, but there are other ways. Like, for example, as we’ve said several times, the structural reforms are essential. Monetary policy is focused on maintaining price stability over the medium term, and its accommodative monetary stance supports economic activity. However, in order to reap the full benefits of our monetary policy measures, other policy areas must contribute decisively. So here we stress the high structural unemployment and the low potential output growth in the euro area as the main situations which we have to address. The ongoing cyclical recovery should be supported by effective structural policies. But there may be other points of view on this. The point is that monetary policy can support and is actually supporting a cyclical economic recovery. We have to address also the structural components of this recovery, so that we can actually move from a cyclical recovery to a structural recovery. Let’s not forget that even before the financial crisis, unemployment has been traditionally very high in the euro area and many of the structural weaknesses have been there before.

Carefully avoiding to mention fiscal policy, when answering a question on fiscal policy, speaks for itself. In fact, saying that “Fiscal policies should support the economic recovery, while remaining in compliance with the EU’s fiscal rules” and putting forward for the n-th time the confidence fairy, amounts to a substantial approval of the policies followed by EMU countries so far. We should stop fooling ourselves: Within the existing rules there is no margin for a meaningful fiscal expansion of the kind invoked by Governor Nowotny. If we look at headline deficit, forecast to be at 2% in 2015, the Maastricht limits leave room for a global fiscal expansion of 1% of GDP, decent but not a game changer (without mentioning the fiscal space of individual countries, very unevenly distributed). And if we look at the main indicator of fiscal effort put forward by the fiscal compact, the cyclical adjusted deficit, the eurozone as a whole should keep its fiscal consolidation effort going, to bring the deficit down from its current level of 0.9% of GDP to the target of 0.5%.

It is no surprise then that the new Italian budget (on which Mario Draghi carefully avoided to comment) is hailed (or decried) as expansionary simply because it slows a little (and just a little) the pace of fiscal consolidation. Within the rules forcefully defended by Draghi, this is the best countries can do. As a side note, I blame the Italian (and the French) government for deciding to play within the existing framework. Bargaining a decimal of deficit here and there will not lift our economies out of their disappointing growth; and more importantly, on a longer term perspective, it will not help advance the debate on the appropriate governance of the eurozone.

In spite of widespread recognition that aggregate demand is too low, Mario Draghi did not move an inch from his previous beliefs: the key for growth is structural reforms, and structural reforms alone. He keeps embracing the Berlin View. The only substantial difference between Draghi and ECB hawks is his belief that, in the current cyclical position, structural reforms should be eased by accommodating monetary policy. This is the only rationale for QE. Is this enough to define him a dove?

And the Winner is (should be)…. Fiscal Policy!

September 4, 2015 2 comments

So, Mario Draghi is disappointed by eurozone growth, and is ready to step up the ECB quantitative easing program. The monetary expansion apparently is not working out as planned.

Big surprise. I am afraid some people do not have access to Wikipedia. If they had, they would read, under “liquidity trap“, the following:

A liquidity trap is a situation, described in Keynesian economics, in which injections of cash into the private banking system by a central bank fail to decrease interest rates and hence make monetary policy ineffective. A liquidity trap is caused when people hoard cash because they expect an adverse event such as deflation, insufficient aggregate demand, or war.

In a liquidity trap the propensity to hoard of the private sector becomes virtually unlimited, so that monetary policy (be it conventional or unconventional) loses traction. It is true that the age of great moderation, and three decades of almighty central bankers had made the concept fade into oblivion. But, since 2008 we were forced to reconsider the effectiveness of monetary policy at the so-called zero lower bound.Or at least we should have…

So, had policy makers taken the time to look at the history of the great depression, or at least to open the Wikipedia entry, they should have learnt that when monetary policy loses traction, the witness in lifting the economy out of the recession, needs to be taken by fiscal policy. In a liquidity trap the winner is fiscal policy.  Or at least it should be. Here is a measure of the fiscal stance, computed as the change in government balance once we exclude cyclical components and interest payments.

2015_09_LiquidityThe vast majority of EMU countries undertook a strong fiscal tightening, regardless of the actual health of their public finances. This generalized austerity, an offspring of the Berlin View, led to our double dip recession, and to further divergence in the eurozone, that would have needed coordinated, not synchronized fiscal policies. Well done guys…

And yet, Mario Draghi is surprised by the impact of QE.

Of Democracy and of a Different Europe

July 6, 2015 3 comments

I have mixed feeling about the Oki victory in Greece. The choice was between two evils: slow death by more of the same (the troika plan), or a roller-coaster ride that has a high chance of ending catastrophically for Greece and for the EMU. I would have voted no, were I Greek, but not joyfully. This said, two things I have been reading in the past days are disturbing:

  1. First, the claim that Tsipras’ rhetoric on democracy is misplaced: After all, people say, we all are democracies. Why should Greek democracy count more than the Portuguese, or the Spanish one? There is no reason, of course. Point is that Tsipras did something that is now really revolutionary in Europe, he tried – hold your breath –  to implement the platform on which he was elected. How many governments in Europe went to power promising an end to austerity, promising a “new deal for Europe”, just to retract a few months/weeks/days later and align themselves with the Berlin View that austerity is the only way? Greek democracy today should count more than democracy in the rest of Europe, because it is the only case in which voters are actually listened to by their government. This is why Syriza’s anomaly needed to be crushed, well beyond the actual content of its proposed policies. If European policy makers feel that their democracy should be as important as Greece’s, they could start by trying to do what their voters elected them for. That would certainly not hurt.
  2. The second thing that bothers me, is the convergence of the establishment and of euro-skeptical movements across Europe. Don’t be fooled by the enthusiastic adherence of many no-euro movements to the Oki campaign Their siding with Tsipras was instrumental to Grexit, turmoil, and weakening the euro itself. Something orthogonal to what Tsipras has been doing and saying in the past two years. The referendum made it clear that the establishment and the no-euro converge in trying to prove that there is no alternative to austerity in Europe. The former, because if Greece is not normalized, we would enter into a new phase in which statements and policies would have to be assessed on the basis of facts (not so favorable to austerity) rather than taken as a matter of faith. Euro skeptics need Tsipras to be crushed because this would definitely prove that the only way to get rid of austerity is to get rid of the euro altogether.

Therefore the referendum, while certainly hazardous and ill-conceived (what did the Greek people vote on, in the end?), had the great merit of exposing the hypocrisy of some commentators, and to show that the only hope for a different Europe has to be found in the struggle that an inexperienced prime minister is leading from Athens. Since yesterday, with the renewed support of his people. Dangerous times ahead, but with a small hope for change.

It’s the Politics, Stupid!

June 27, 2015 22 comments

Update: 6/30:  A very interesting piece by BrankoMilanovic, made the same point before me

I have been silent on Greece, because scores of excellent economists from all sides commented at length and in real time on the developments of negotiation, and most has been said.

But last week has transformed in certainty what had been a fear since the beginning. The troika, backed by the quasi totality of EU governments, were not interested in finding a solution that would allow Greece to recover while embarking in a fiscally sustainable path. No, they were interested in a complete and public defeat of the “radical” Greek government.

The negotiation has not been one. The two sides were very far in January, as it is and it should be, if two radically different views about the engines of growth confront each other. Syriza wanted the end of austerity, that was much harsher on the country than expected, while failing to bring the promised benefits, even in terms of public finances’ sustainability. And it wanted the burden of debt to be lifted The troika wanted get its money back (well, not all of it; the IMF has always been open to debt restructuring), and more of the policies imposed to Greece since 2010, because, well, “eventually they will work”. (no need for me to remind with whom I have been siding).

But there was a common ground that, had the negotiation been real, could have allowed to reach an agreement, in just a few weeks of discussion. Both sides agreed that the Greek economy is broken, and that it needs radical reform. While Syriza focused on reorganisation of the State, on putting together a functioning tax collection system, at closing inefficiency loopholes, the troika demands were more “classic” and somewhat ideological: pension cuts, labour market reform, and the like. A continuation of the memorandum, in fact.

If we look at the economics of it, Sequencing is crucial: implementing structural reforms in bad times, when the economy is not able to absorb the short run costs of such reforms, imposes excessive disruption and risks hampering the potential long run benefits. This is why the joint implementation of austerity and structural reforms is particularly pernicious. Their short run contractionary effects reinforce each other and may be self-defeating, leading to no improvement in productivity or in public finances’ health. The dire state of Greece’s economy stands as a reminder that such an outcome is all but impossible. Troika reforms and cuts to public spending were doomed to fail since the beginning.

What happened since then? Well, contrary to what is heard in European circles, most of the concessions came from the Greek government. On retirement age, on the size of budget surplus (yes, the Greek government gave up its intention to stop austerity, and just obtained to soften it), on VAT, on privatizations, we are today much closer to the Troika initial positions than to the initial Greek position. Much closer.

The point that the Greek government made repeatedly is that some reforms, like improving the tax collection capacity, actually demanded an increase of resources, and hence of public spending. Reforms need to be disconnected from austerity, to maximize their chance to work.  Syriza, precisely like the Papandreou government in 2010 asked for time and possibly money. It got neither.

Tsipras had only two red lines it would and it could not cross: Trying to increase taxes on the rich (most notably large corporations), and not agreeing to further cuts to low pensions. if he crossed those lines, he would become virtually indistinguishable from Samaras and from the policies that led Greece to be a broken State.

What the past week made clear is that this, and only this was the objective of the creditors. This has been since the beginning about politics. Creditors cannot afford that an alternative to policies followed since 2010 in Greece and in the rest of the Eurozone materializes.

Austerity and structural reforms need to be the only way to go. Otherwise people could start asking questions; a risk you don’t want to run a few months before Spanish elections. Syriza needed to be made an example. You cannot  survive in Europe, if you don’t embrace the Brussels-Berlin Consensus. Tsipras, like Papandreou, was left with the only option too ask for the Greek people’s opinion, because there has been no negotiation, just a huge smoke screen. Those of us who were discussing pros and cons of the different options on the table, well, we were wasting our time.

And if Greece needs to go down to prove it, so be it. If we transform the euro in a club in which countries come and go, so be it.

The darkest moment for the EU.


Reform or Perish

June 19, 2015 2 comments

Very busy period. Plus, it is kind of tiresome to comment daily ups and downs of the negotiation between Greece and the Troika Institutions.

But as yesterday we made another step towards Grexit, it struck me how close the two sides are on the most controversial issue, primary surplus. Greece conceded to the creditors’ demand of a 1% surplus in 2015, and there still is a difference on the target for 2016, of about 0.5% (around 900 millions). Just look at how often most countries, not just Greece, respected their targets in the past, and you’ll understand how this does not look like a difference impossible to bridge.

The remaining issue is reforms. Creditors argue that Greece cannot be trusted in its commitment to reform. After all, they cheated so often in the past… In particular, creditors point at one of Syriza’s red lines, the refusal to touch pension reforms, as proof that the country is structurally incapable of reform. And here is the proof, the percentage of GDP that crisis countries spent in welfare::


I took total social expenditure that bundles together pensions, expenditure for supporting families, labour market policies, and so on and so forth. All these expenditure that, according to the Berlin View, choke the animal spirits of the economy, and kill productivity.

Well, Greece does not do much worse than its fellow crisis economies, but it is true that it is hard to detect a downward trend. The reform effort was not very strong, and certaiinly not adapted to an economy undergoing such a terrible crisis. The very fact that after four years of adjustment program the country spends 24% of its GDP in social protection, is a proof that it cannot be trusted.This is just proof that, once more, the Greek made fun of their fellow Europeans, and that they want us to pay for their pensions.

Hold on. Did I just say “terrible crisis”? What was that story of ratios, denominators and numerators? The ratio is today at the same level as 2009. But what about actual expenditure? There is a vary simple way to check for this. Multiply each of the lines above for the value of GDP. Here is what you get (normalized at 2009=100, as country sizes are too different):


The picture looks quite different, does it? Greece, whose crisis was significantly worse than for the other countries, slashed social expenditure by 25% in 5 years (I know, I know, it is current expenditure. I am too busy to deflate the figure. But I challenge you to prove that things would be substantially different). Now, just in case you had not noticed, social expenditure has an important role as an automatic stabilizer: It supports incomes, thus making hardship more bearable, and lying the foundations for the recovery. In a crisis the line should go up, not down. This picture is yet another illustration of the Greek tragedy, and of the stupidity of the policies that the Troika insists on imposing. By the way, notice how expenditure increased from 2005 to 2009, in response to the global financial crisis. A further proof that sensible policies were implemented in the early phase of the crisis, and that we went berserk only in the second phase.

Ah, and of course virtuous Germany, the model we should all follow, is the black line. Do what I say…

One may object that focusing on expenditure is misleading. There is more than expenditure in assessing the burden of the welfare state on the economy. While Greece slashed spending, its welfare state did not become any better; its capacity to collect taxes did not improve, that its inefficient public administration and its crony capitalism are stronger than ever. Yes, somebody may object all that. That someone is Yanis Varoufakis, who is demanding precisely this: stop asking that Greece slashes spending, and lift the financial constraint that prevents any meaningful medium term reform effort. Reform is not just cutting expenditure. Reform is reorganization of the administrative machine, elimination of wasteful programs, redesigning of incentives. All that is a billion times harder to do for a government that spends all its energies finding money to pay its debt.

Real reform is a medium term objective that needs time, and sometimes resources. In a sentence, reform should stop being associated with austerity.

But hey, I am no finance minister. Just sayin’…


The Confidence Witch

March 25, 2015 3 comments

Remember the old times? Here is a quote from ECB President Jean-Claude Trichet, September 2nd, 2010:

[Fiscal Consolidation] is a prerequisite for maintaining confidence in the credibility of governments’ fiscal targets. Positive effects on confidence can compensate for the reduction in demand stemming from fiscal consolidation, when fiscal adjustment strategies are perceived as credible, ambitious and focused on the expenditure side. The conditions for such positive effects are particularly favourable in the current environment of macroeconomic uncertainty.

And just in case it was not clear, on September 3rd, 2010:

We encourage all countries to be absolutely determined to go back to a sustainable mode for their fiscal policies,” Trichet said, speaking after the ECB rate decision on Thursday. “Our message is the same for all, and we trust that it is absolutely decisive not only for each country individually, but for prosperity of all.”

“Not because it is an elementary recommendation to care for your sons and daughter and not overburden them, but because it is good for confidence, consumption and investment today”.

Well, think again. Here is the abstract of ECB Working Paper no 1770, March 2015:

We explore how fiscal consolidations affect private sector confidence, a possible channel for the fiscal transmission that has received particular attention recently as a result of governments embarking on austerity trajectories in the aftermath of the crisis. Panel regressions based on the action-based datasets of De Vries et al. (2011) and Alesina et al. (2014) show that consolidations, and in particular their unanticipated components affect confidence negatively. The effects are stronger for revenue-based measures and when institutional arrangements, such as fiscal rules, are weak. To obtain a more accurate picture of how consolidations affect confidence, we co nstruct a monthly dataset of consolidation announcements based on the aforementioned datasets, so that we can study the confidence effects in real time using an event study. Consumer confidence falls around announcements of consolidation measures, an effect driven by revenue-based measures. Moreover, the effects are most relevant for European countries with weak institutional arrangements, as measured by the tightness of fiscal rules or budgetary transparency. The effects on producer confidence are generally similar, but weaker than for consumer confidence.

The confidence fairy seems to have turned into a confidence witch. One more victim of the crisis. But this one will not be missed.

It is not shameful to change opinion. Rather the contrary, it is a sign of intellectual courage. Two years ago, the IMF famously surprised commentators worldwide with a rather substantial U-turn on the impact of austerity. Revised calculations on the size of multipliers led them to acknowledge that they had underestimated the impact of austerity on economic activity.

Even at that time it started with a technical paper. But significantly, that paper was coauthored by Olivier Blanchard, IMF Chief Economist. It then served as the basis for a progress report on Greece, in June 2013, that de facto disavowed the first bailout program arguing that austerity had proven to be self-defeating.

Let us just hope that in the ECB new building communication between the research department and the top guys is more effective than in the old one…

I am glad to give credit for the title to Merijn Knibbe, from Real-World Economics Review Blog, who used the term in a comment to my last post.