BlogSpot - November 15th, 2013
Ask again: is the Eurozone crisis over?
This week brought some reasons to be cheerful in the eurozone. As noted in EuroIntelligence, Prime Minister Kenny announced that Ireland’s graduation from the EU/IMF program without a precautionary credit line (read Stephen Collins in the Irish Times). Olli Rehn reiterated the EC’s support and the IMF stressed Ireland’s ‘very strong track record of policy implementation’ (see also the Eurogroup supportive statement). For Reuters, this is a return “to normal economic, budgetary and funding conditions.” Some commentators noted that this leaves the country with few buffers (e.g., Lucinda Creighton in the WSJ and The Guardian). Spain’s financial sector programme was also deemed successful by the Eurogroup—as the country announced it will not request an extension of ESM financial assistance.
However, signals about recovery in Europe are mixed. FreeExchange comments that Q3 2013 growth in the euro area was a mere 0.1 percent, mainly from a slowdown in Germany, and actual output declines in France and Italy, the second and third largest respectively. FreeExchange is concerned about the mixture of meagre growth and low inflation. EuroIntelligence also notes that the eurozone’s economic recovery is weak, fragile and uneven, with record unemployment. In the UK, behind the robust numbers posted by the Bank of England, the FT notes a wide gap between the strong performance of some industries and low public confidence. The Eurostat flash estimate drew a comparison with US real GDP growth demonstrating impressively how much Europe laggs behind the US since 2010. IMF economists Fabian Bornhost and Marta Ruiz Arranz, in a VoxEU piece, provide some insight as to the challenges going forward: high levels of private and public debt (as experienced in Europe), together with deleveraging of all sectors, are especially harmful for economic growth—calling for policies aimed at reducing the private debt.
Monetary policy as first line of defense: the Eurozone flirts with the Zero-Lower-Bound
One step further for the EZ. The ECB lowered its interest rate on main refinancing operations to 0.25 percent and announced that it will continue its large liquidity injections with full allotment and fixed interest rates for as long as necessary.
The pursuit of such a strongly accommodative monetary policy follows the publication last October of Eurostat’s CPI estimations for the Eurozone at 0.7 percent, far from the ECB’s target of 2 percent and, as mentioned in Free Exchange, lower than in Japan. In FT Alphaville, Dan McCrum points out that such a move tightens yet again the ECB’s available corridor for action and could lead the markets to believing the easing cycle is over. Nevertheless, as pointed out in FreeExchange, avoiding deflation is crucial for the eurozone to deal with excessive indebtedness and to boost their competitiveness.
Lowering interest rates was a first: with Mario Draghi insisting that the ECB has several other strings to its bow. EuroIntelligence agrees with Adam Posen that strong forward guidance, clearer targets and further liquidity injections are inevitable given the fragile current economic situation in the eurozone—a position strongly supported by Paul Krugman who more specifically advised central banks to wait for signs of inflation before exiting.
Too little LTRO too late? No immediate action à la LTRO could have serious consequences, as banks remain focused on de-risking their portfolios and paying back existing LTRO funds. In a transcript by FT Alphaville, Lena Komileva warns about greater exposure to external liquidity shocks with investor expectations of Fed tapering. Yet, further LTRO could be hindered by the upcoming implementation of the Asset Quality Review of banks’ balance sheets in the EZ as Izabella Kaminska reminds us in FT Alphaville.
One step too far for Germany? According to EuroIntelligence and Simon Wren-Lewis (Mainly Macro), the German reaction to the rate cut has been fierce—though Paul Krugman (in his Conscience of being liberal blog) stresses that Germany’s large current account surplus is partly to blame for deflationary trends. Dani Rodrik, in a Project Syndicate article, supports this claim by comparing the economic performance of countries running deficits versus those who benefit from current account surplus. Benoît Coeuré reacted to the reservations expressed by some of Germany’s economists in a speech where he argued that higher key interest rates would have exacerbated the recession, delayed the recovery and contributed to deflationary risks.
The Economist’s FreeExchange blog engaged a broader debate on the nature of monetary policy, building on a recent report by the McKinsey Global Institute assessing the distributional effects of unconventional monetary policy (UMP). Richard Dobbs and Susan Lund provided a summary: stressing the distributional impact of QE and the associated risks: a potential 20 percent increase in debt-service costs if interest rates rise back to 2007 levels—and rates even then were not very high. For the authors, policies created an uncharted interest rate environment, with a possibly bumpy exit. Stephen King insists that UMP is an on-going experiment, and that its continuation removes incentives for governments to undertake solid fiscal reforms. He worries about the fact that companies have chosen not to invest on the back of substantial equity gains, a sign that QE may lead to further capital misallocation. Mohamed A. El-Erian stresses the limits of monetary policy, as exorbitant monetary policy actions is a risk to credibility. The Wall Street Journal argues that monetary policy can only play a secondary role to financial and real sector reforms, a point reinforced by Michel Barnier at the EPC Annual Conference.
The short view: Discipline in the eurozone—let’s talk about Germany…
The 2014 European Semester cycle was launched with the release of: the Annual Growth Survey, the Alert Mechanism Report, the Draft Joint Employment Report, the Single Market Integration Report, and its Opinion on Budget Laws. With attention focused on Germany, the European Commission’s macroeconomic imbalance procedure is likely to be quite ineffective, according to Daniel Gros (in a CEPS article). Read last week’s WS Blogspot for more details.
