BlogSpot - November 1st, 2013
Future of the monetary policy and the financial stability raises concerns
Demand support through monetary policy and its discontent... FreeExchange argues that real rates are too high, based on a Wicksellian rate applied to households expectations about their income—resulting in low domestic demand. This supports continued monetary accommodation, a point also defended by Credit Suisse (hat-tip Izabella Kaminska) and by the Bank of England. The former is concerned about deflation (in Spain and more widely the euro area), driven by high unemployment rates. For Credit Suisse, the current asset quality review makes increases the likelihood of a rate cut.
The austerity debate continues—calling for consolidation not to interfere with monetary demand support. Mainlymacro criticizes countries overdoing fiscal consolidation because of spillovers effects (a reminder of Jan Veld’s recent paper). RealTimeBrussels denounces technicalities, such as structural budget balance or NAWRU (article) calculations, as forcing greater than needed adjustment.
The Bank of England announced significant changes to the Sterling Monetary Framework’s (SMF) liquidity insurance (liquidity at longer maturities, against a wider range of collateral, at a lower cost and with greater predictability) toolkit to increase the availability and flexibility of liquidity insurance. FreeExchange underlines the risk that such efforts to raise bank lending to the real economy turn actually into an imbalance growth favoring services and construction and feeding a rise in property prices. MainlyMacro stresses the importance of avoiding policy uncertainty and advocate in favor of forward guidance.
Christina D. Romer insists on the importance of the financial stability mandate of central banks in a review article on the lessons from the crisis. She brings out four main lessons: (i) financial crises can be devastating; (ii) the zero-lower bound constraint; (iii) the importance of expectations management; (iv) the role of monetary policy to ease the pain from fiscal adjustment—and calls for monetary expansion and higher bank capital requirements.…
And the need of financial stability. Benoit Coeuré, in his speech at the Asia Europe Economic Forum, reminded us the need to restructure financial sector with a comprehensive clean-up of the banking system, a reduction in financial fragmentation and the development of non-bank financing. Jörg Asmussen outlined, in a speech at Bocconi University, U.S. lessons for Europe in how to supervise banks at minimum costs to the taxpayer. First, banking union will prevent local crises from becoming systemic and will break vicious bank-sovereign feedback loops while repairing monetary policy transmission channels. Two elements are indispensable: a Single Supervisory Mechanism (SSM) and a Single Resolution Mechanism (SRM). Second, an integrated financial market would dissipate the costs of crises through better risk diversification.
The ability of the ECB to ensure financial stability is questioned. Nicolas Véron, in a Bruegel post, highlights monumental challenges to come with undercapitalized banks in the form of political interference. Whether the ECB opts for forbearance or rigor is likely to trigger financial market volatility. Jennifer Kapila, in Roubini, argues that the AQR will be more credible than previous tests, but that its duration and conductor—the ECB is the arbiter of price and financial stability—reduce the potential for negative market reactions; and that public- and private-sector balance sheets are more capable of backstopping the banking system than in previous stress tests. Implementation challenges are also high: Euromoney quotes R. Ruparel (Open Europe) with doubts on the likelihood of an operational SRM before 2015 and on its effectiveness due to the small proposed bank resolution fund (€55 billion).
The (forgotten) Europe 2020 Strategy targets and the lack of summit ambition
The European Commission (press release) reminded us that the Europe 2020 Strategy outlined a plan to get the EU back on track with five reform priorities: differentiated growth-friendly fiscal consolidation, restoring lending to the economy, promoting growth and competitiveness, tackling unemployment and reforming labor markets and modernizing public administrations. RealTimeBrussels show that program eurozone countries slipped away from the initial targets for economic and social performance. Benoit Coeuré recommended (speech) fostering growth by investing in physical and human capital: at the national level, productivity-enhancing investment and market flexibility. The OECD asserts that support for young firm would boost jobs creation as the crisis showed that “most jobs destroyed were the results of old business downsizing while net job growth in young firms remained positive” (see our WS killer chart). Europe’s ability to keep a strong pace of regulatory reforms to ease business (shown by the World Bank in its comment of Doing Business 2014) is encouraging.
The recent Summit fell short in ambitions. J.A. Emmanouilidis regrets the lack of major initiatives on key topics such as innovation, service and youth employment, distracted by the NSA scandal. KeepTalkingGreece denounced the EU’s lack of action, with a quote from P. Matjašic, president of the European Youth Forum, arguing that EU spent more in cows than in young people. This is concerning as anti-EU parties are gaining popularity, with a a legitimacy crisis in Europe (B. Ceka). Jacob Funk Kirkegaard (Peterson Institute) stresses three main takeaways from the recent Summit (here are the Council Conclusions): the importance of intellegience issues (in the context of the NSA scandal), the continuation of the incremental approach, the fact that the ECB has lost the debate about bank creditor bail-ins (with a clear position).
The Short View…
A mixed picture for program countries’ return to the market, according to Roubini.com. William Oman expects Ireland to apply for a precautionary credit line to allow for an orderly return to the markets; Christian Odendahl sees the official sector putting softer debt terms via maturity extensions or interest-payment deferrals allowing Greece to gradually achieve debt sustainability; and William Oman assesses that Portugal will require a second financial assistance program.
