BlogSpot - October 25th, 2013
Europe still struggles to find the right path into recovery
Scenarios for future eurozone growth are slowly improving. In a comprehensive review of the eurozone economy, a Roubini team presents different scenarios for the eurozone. The baseline is a muddle-through, predicting still local and mostly contained political risks, with sovereign risks contained through soft official restructuring and postponement of adjustment measures. Their downside scenario (given a 20 percent probability) has political risk escalating, especially in Italy, and low growth leading to a renewed crisis. On a more positive note, EuroIntelligence suggests that the eurozone growth consensus is hedging upward, to 1.5 percent in 2014. In Bruegel, the Glienicker Group (composed of 11 German economists) warns against complacency and calls for a deeper Euro Union and structural solutions to current problems—a proposal counter to popular beliefs in Germany. deeper integration, in four areas: (i) a symmetric approach to deal with debt problems (responsible debtors need responsible creditors), avoiding the mutualization of bad credit by private creditors; (ii) responsibility and solidarity go hand in hand, which implies a controlled transfer mechanism, a common unemployment insurance system, regional investment plans; (iii) better democratic accountability, with a sanctions mechanism to enforce adherence to the EU principles, and (iv) bestowal of public goods. Again, the determinants of the outlook are being reviewed:
The role of austerity, reviewed again… Real Time Brussels, Matina Stevis refers to a controversial article published by Jan Feld, economist at the European Commission, stating that coordinated austerity in euro-area countries has stifled economic recovery and deepened the crisis across the Euro Zone. Feld emphasizes the role of negative spillovers from the tight fiscal in Germany and calls for limited stimulus programs in richer countries to help regional growth. Michael Keen, in VoxEu, warns that most Eurozone countries did not comply with IMF advice on fiscal policy, and more specifically fiscal devaluation.
The implications of a monetary union… Michael Bordo and Harold James (VoxEu) compare the current crisis to the interwar period, when the Gold standard was imposing similar constraints as the EMU, and argue that the impossibility to exit the monetary union largely explains the slow recovery. However, Antonio Fatas writes that monetary regimes have no significant effect on economic performance—in particular, eurozone membership has not been a negative for periphery countries. Paul Krugman disagrees, for two reasons: (i) nominal wage stickiness, (ii) the prevailing positive correlation between debt levels and borrowing costs.
Bringing forward the banking union
The ECB officially started its asset quality review (AQR) (see the press release) to foster transparency, to repair and to build confidence. The AQR will focus on large banks The assessment will commence in November 2013 and will take 12 months to complete—in collaboration with the national authorities. The assessment will consist of three elements: i) a supervisory risk assessment to review, quantitatively and qualitatively, key risks, including liquidity, leverage and funding; ii) an asset quality review (AQR) to enhance the transparency of bank exposures by reviewing the quality of banks’ assets, including the adequacy of asset and collateral valuation and related provisions; and iii) a stress test to examine the resilience of banks’ balance sheet to stress scenarios. According to Handelsblatt, Europe's largest banks still face recapitalization problems. Rebecca Christie, in Bloomberg News, commented on the list of 124 “significant” euro-area banks, most in Germany (24), Spain (16), Italy (15) and France (13). The list includes banks which, as of the end of 2012, had assets of more than 30 billion euros or that represent 20 percent of their home country’s gross domestic product. Silvia Merler, in a Bruegel blog, stresses the risk connected to the normalization of liquidity condition in the Eurozone, especially as reliance on central bank liquidity is uneven across countries. The OMT announcement in September 2012 reversed the banking system’s reliance on ECB liquidity, with early LTRO repayment perceived as a a reputational signal.
The AQR exercise is closely linked to the banking union prospects. For Thorsten Beck, in a VoxEU update of an e-book on the banking union, the struggle about the shape of the banking union is bad news for the effectiveness of the AQR—in particular, what will happen if recapitalization needs are concentrated in economies with weaker sovereign backstops. To solve immediate problems, he proposes the establishment of an asset management company or European Recapitalization Agency. He stresses the lack of progress on the banking union—in particular on the bank resolution and deposit insurance pillars. Nicolas Veron, in a Bruegel opinion piece, noted (in a pre-summer speech) that the banking union is key to address the mismatch between comprehensive market integration and the preservation of national banking sector policies—which created powerful incentives for national authorities to promote or defend “their” banks on the European playing field and introduce competitive distortions harmful to financial stability. Angel Ubide, in a Peterson Institute article, proposes a closer integration (rather than current proposals focused on national resolution authorities and funds for insolvent financial institutions, a minimal euro area financing backstop, and costs imposed on creditors of failed banks)—with centralized supervision, a European resolution authority and a European resolution fund. According to Süddeutsche Zeitung and FAZ, Angela Merkel will propose a new procedure for bank resolution—and Germany will accept a common resolution fund under three conditions: (i) national parliaments have to vote each time any money disbursed; (ii) the fund is limited to the 130 banks under ECB supervision only (including up to 30 German banks); and (iii) a bail-in cascade has to be in place.
A reminder: the U.S. Government shutdown has ended … for now
U.S. Congress ended the government shutdown. Telos exposes the terms of the agreement: (i) an increase in the debt ceiling until February 7, 2014 - averting an unprecedented debt default; (ii) a release of the government’s operating funds until January 15, 2014 - putting an effective end to the government shutdown; (iii) the organization of a bi-partisan conference on the U.S. fiscal policy. The agreement postpones key deadlines. FT Alphaville alerts that Dagong rating agency downgraded the U.S. to A- from A. Analysts are looking into the root causes of this impasse. In a Project Syndicate article, Katharina Pistor argues that structural commitments not to raise taxes and excessive reliance on debt finance undermine self-governance—she calls for a political union to manage debt effectively. Paul Krugman have reservations about the U.S. bipartite system. He writes that political decisions suffer from a “Backfire effect”. Particular media and social movements such as Fix the Debt are also held accountable for exacerbating the crisis.
Foreign analysts expressed concerns about potentially severe spillovers. In a Project Syndicate commentary, José Antonio Ocampo pinpoints two consequences for the international monetary system: a deeper uncertainty about the dollar and further delays about the IMF’s 2010 quota and governance reform. He argues that the IMF should be given a greater role as an effective instrument of global macroeconomic policy coordination.
By Aliae Sayah
