BlogSpot – September 13th, 2013
What recovery for the eurozone? Making sense of the green shoots and cautioning against complacency
Barry Eichengreen, in Project Syndicate, asks whether two quarters of economic growth make a recovery. Despite strong commitment from eurozone political leaders, Europe risks a hard landing—with weak banks and a debt overhang, and policies that have been insufficient to ensure success.
In a VoxEU article, Marco Butti and Pier Carlo Padoan argue that policymakers should not be complacent with a weak recovery in the eurozone. FreeExchange warns on the risk of complacency (see for example Olli Rehn statement)—especially given major internal divisions and the importance of the pace of the rebound. Open Europe sees some signs of such complacency in Barroso’s State of the Union address—with the old fall back on greater political integration as the cure to all ills. Butti and Padoan highlight the impact of slow deleveraging and bank balance sheet repair. For them, addressing the weakness of domestic growth, exploiting the cyclical developments to make growth more sustained and sustainable, and therefore removing impediments to private investment, is vital—as is reducing policy uncertainty.
Quid of policies? Still divided on the benefits of consolidation…
Looking back, analysts are divided on the benefits that consolidation policies have yielded. Daniel Gros, in a Project Syndicate commentary, argues that while austerity has failed to stabilize the debt ratios, it is beneficial for the long-run solvency of peripheral countries, especially when accompanied by structural reforms, because it improves potential growth. In the short-term, austerity has had the additional benefit of restoring external balances in the periphery. Paul Krugman, on his blog, argues on the contrary that the real issue is the imposition of contractionary policies.
Zsolt Darvas, in a Bruegel article, discusses the negative relationship between competitiveness (which requires low inflation) and debt sustainability (facilitated by higher inflation), made more severe in the euro area by the conflict between intra-euro relative price adjustment and debt sustainability is more severe. Erkki Vihnala, in another Bruegel article, looks at the specifics behind low inflation in the eurozone. For Darvas, the top priority is to ensure that euro area inflation does not undershoot the two percent target and he places emphasis on accommodative monetary policy, in addition to more effective policies to foster growth.
Yannos Papantoniou, in Project Syndicate, stresses that « European orthodoxies » that praised surplus countries and criticized deficit economies failed because of a lack of either a full federation or a transfer union model, with self-defeating austerity policies. He proposes a five-pronged approach to get back to the required growth path: (i) relaxed fiscal stances in fiscally sound economies, (ii) further unconventional monetary policy to reduce interest rates, (iii) partial debt mutualization at the European level, (iv) a real banking union, and (v) stronger and more accountable European institutions.
FreeExchange looks at a new paper by Kevin O’Rourke and Alan Taylor that compares the American and euro-area currency zones. They find that the euro area differs from the US because of interest rate divergence: i.e., no matter how the ECB sets policy, many of its regions are confronting an inappropriate policy rate—and the US has greater labor mobility, a central fiscal authority, and an expectation that states could default. The euro zone has only been around for a few years. But time is not on the euro’s side, and there seems little political will to take the American way.
Franz Nauschnigg, in Project Syndicate, takes a different approach to the problems of peripheral Europe, noting that they have suffered from larger deficits with China than with the rest of Europe, driven by the nominal appreciation of the euro and intense competition on specific sectors (textiles, clothing, and footwear). He concludes that, with limited policy space elsewhere, the solution for a weakened Europe could be a weaker euro.
But against the risk of protracted slow growth, growth is back at the center of the agenda.
Enrico Letta, also in Project Syndicate, calls for pragmatism and for placing economic growth at the top of the political agenda in Europe. Mohamed El Erian (Project Syndicate) writes that the returned sense of normality in Europe is the result of temporary and potentially reversible factors. Officials need quickly addressing economic challenges in a more comprehensive manner. For El Erian, 4 micro-level challenges are critical: joblessness, adjustment fatigue, bailout fatigue, and disrupted financial intermediation—in the context of a worsening external environment.
Jean Pisani-Ferry (Project Syndicate) reflects on the role of structural reforms, viewed as a new mantra for growth in Europe. But he writes that a reform strategy requires solving two problems. First, pro-growth reform requires substituting efficient arrangements for inefficient ones but also confronting hard political choices. The second problem in designing structural reform is one of strategy—reform should start with the most binding constraint to performance and then implies hard choices about priorities and sequencing.
Jacob Funk Kirkegaard, in a Real Time Economic Watch entry, is rather optimistic on the ability for European policymakers to make progress, even in the absence of a full fiscal backstop (a response to those who view the adoption of an imperfect SSM as insufficient). He argues that the key element resides in the urgent need to reform the banking sector is urgent—stressing the importance of the upcoming stress tests, and listing other useful steps, such as establishing a genuine regulatory “Single Rulebook,” strengthening supervision at the European level and completing resolution mechanisms. If these steps are a success, Funk Kirkegaard argues that eurobonds, fiscal union, and unlimited backstops can wait for the future.
Jacob Funk Kirkegaard, in a Briefing to the President of the Eurogroup, highlights how recent successful stabilization efforts in the euro area have shifted the main policy challenge from “acute crisis management” to fighting chronic stagnation. His recommendations focus on critical policy challenges concerning euro area financial sector reforms and the upcoming banking sector balance-sheet assessment and stress test, as well as continuing reducing excessive inactivity levels.
