Posts Tagged ‘EMU Crisis’

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:
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 I agreed then and I agree now: government support to the economy was withdrawn when the private sector was only partially in condition to take the witness.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:
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.


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:

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?

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…


Draghi Wants the Cake, and Eat It

February 16, 2016 6 comments

Yesterday Mario Draghi has called once more for other policies to support the ECB titanic (and so far vain) effort to lift the eurozone economy out of its state of semi-permanent stagnation. Here is the exact quote from his introductory remarks at the European Parliament hearing:

In parallel, other policies should help to put the euro area economy on firmer grounds. It is becoming clearer and clearer that fiscal policies should support the economic recovery through public investment and lower taxation. In addition, the ongoing cyclical recovery should be supported by effective structural policies. In particular, actions to improve the business environment, including the provision of an adequate public infrastructure, are vital to increase productive investment, boost job creations and raise productivity. Compliance with the rules of the Stability and Growth Pact remains essential to maintain confidence in the fiscal framework.

In a sentence, less taxes, more public investment (in infrastructures), and respect of the 3% limit. I just have two very quick (related) comments:

  1. Boosting growth remaining within the limits of the stability pact simply cannot happen. I just downloaded from the Commission database the deficit figures and the growth rate for 2015. And I computed the margin (difference between deficit and the 3% SGP limit). Here is what it gives:
    Not only the margin for a fiscal expansion is ridiculously low for the EMU as a whole (at 0.8% of GDP, assuming a multiplier of 1.5 this would give globally 1.2% of extra growth). But it is also unevenly distributed. The (mild) positive slope of the yellow trend line, tells us that the countries that have a wider margin are those which need it the less as, overall, they grew faster in 2015. Said otherwise, we should ask the same guys who are unable to show a modicum of decency and solidarity in managing a humanitarian emergency like the refugee crisis, to coordinate in a fiscal expansion for the common good of the eurozone. Good luck with that…
    Mr Draghi is too smart not to know that the needed fiscal expansion would require breaching the limits of the pact. Unless we had a real golden rule, excluding public investment from deficit computation.
  2. So, how can we have lower taxes, more investment, and low deficit? The answer seems one, and only one. Cutting current expenditure. And I think it is worth being frank here: Besides cutting some waste at the margin, the only way to reduce current public expenditure is to seriously downsize our welfare state. We may debate whether our social model is incompatible with the modern globalized economy (I don’t think it is). But pretending that we can have the investment boost that even Mr Draghi today think is necessary, leaving our welfare state untouched, is simply nonsense. You can’t have the cake and eat it.

Therefore, what we should be talking about is our social contract. Do we want to keep it or not? Are we ready to pay the price for it? Are we aware of what the alternative of low social protection would imply? Are our institutions ready for a world in which automatic stabilization would play a significantly lesser role? If after considering these (and other) questions, the EU citizen decided, democratically, to abandon the current EU social model, I would not object to it. I would disagree, but I would not object. The problem is that this change is being implemented, bit by bit, without a real debate. I am no fan of conspiracy theories. But when reading Draghi yesterday, I could not avoid thinking of an old piece by Jean-Paul Fitoussi, arguing that European policy makers were pursuing an hidden agenda  (I have discussed it already). The crisis weakened resistance and is making it easier to gradually dismantle the EU social model. The result is growing disaffection, that really surprises nobody but those who do not want to see it. An Italian politician from an other era famously said that to think the worst of someone is a sin, but usually you are spot on…

Draghi the Fiscal Hawk

October 23, 2015 8 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 4 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.