BlogSpot - November 22nd, 2013
Growth heading towards secular stagnation…
The OECD revised its global growth outlook—predicting a slow recovery, with headwinds from emerging markets, and worries about deflationary risks.
The new buzz word in policy circles is “secular stagnation,” coined Larry Summers in a speech at the IMF Research Conference. He warned about a possible new normal of stagnation in advanced economies, akin to the Japanese experience of the last two decades. Paul Krugman supports Summers’ argument by arguing that expansionary monetary policy in the past two decades has been key to avoiding getting into a liquidity trap—which is unfortunately becoming a new normal, associated with slower growth and investment, and declining labor force participation, and compounded by tougher financial regulation. Martin Wolf (hat tip EuroIntelligence) argues that a global savings glut has become a constraint on current demand, and also on supply and agrees with Summers’ main policy conclusion that the way out is through government investment. Yet institutional constraints (e.g., in the eurozone with the stability pact, fiscal compact, six-pack and two pack) impede this policy.
What solutions to avoid secular stagnation? Making monetary policy more expansionary is important. Yet interest rate appear to be naturally low, according to Free Exchange—due to a mix of global savings glut, widespread deleveraging, and demographic or technological trends, leading to a revival of the debate about nominal inflation targets (see for example Robert Hall). In Quartz, Miles Kimball suggests accepting negative interest rates to support demand. Krugman however notes the social difficulty of implementing negative interest rates, and proposes instead higher inflation (an option rejected by Ryan Avent). This is an opportunity for Olivier Blanchard to revive his proposal to target a higher level of inflation. In his Spiegel column, Wolfgang Münchau writes that if the equilibrium real interest rate is negative, there are only—unlikely—three solutions: the abolition of banknotes and coins to allow central banks to push big below the zero lower bound; the wholesale nationalization of the financial sector to depress lending rates to companies; and heavy state investments to drive up the equilibrium interest rate to above zero.
Arnold King takes a counterpoint, rejects the proposal for negative real rates—which he does not see as leading to growth, and questions the view that full-employment can be achieved through sustained asset bubbles.
Is the blame on deflationary surpluses?
The debate around Germany’s current account surplus is amplified in the context of the weak growth outlook despite Joerg Asmussen calls for a more comprehensive understanding. In Project Syndicate, Kemal Dervis notes that Germany’s current account surpluses put upward pressure on the euro, further undermining the competitiveness of Southern countries. For The Economist, Germany’s surplus could be a problem for Germans too, resulting from weak domestic demand and measures to boost domestic investment (through public infrastructure and deregulation) are recommended. Indeed for Michael Spence (Project Syndicate) Germany suffers from both insufficient domestic aggregate demand and an outsized tradable sector—and this unbalanced growth model is supported by an undervalued real exchange rate.
Also in Germany’s interest is supporting other eurozone countries. The Economist notes that while Germany’s surplus is high, it is declining with other Eurozone countries since 2007 due to weak demand from those economies. Marcel Franzscher further reminds Germany, in a Project Syndicate article, that growth and dynamism in Europe helped its recovery in the early 2000s.
The debate on sovereign debt restructuring opens up
A paper by the Bank of England and the Bank of Canada argues that the current approach to sovereign crisis in Europe is suboptimal as it (i) increases moral hazard; (ii) incentivizes short-term lending; (iii) puts tax-payer resources at risk; (iv) complicates negotiated debt write-downs by substantial official sector holdings; and, (v) can delay and make more costly necessary policy adjustments. The paper proposes ‘sovereign cocos’ and ‘GDP-linked bonds’ to tackle liquidity crises (for the former instrument) and solvency crises (for the latter). Jason Douglas, in RealTime Brussels, notes that a similar proposal was put forward by Bruegel (and assessed on Real Time Brussels) but that they are gain traction in policy circles.
While questions are raised about bail-in policies… RBS analysts, in a recent study, argue that the European Union's Council raised the stakes in the "Bail-in Wars" with a statement on the creation of national backstops ahead of the asset quality review in November next year. Burden-sharing will be applied if enough private capital cannot be raised, and countries which do not have a resolution regime must set one up before the stress tests conclude. ESM funds will be available, but only after appropriate bail-in has been applied - first in the form of a loan to the sovereign and only after that can the EUR 60bn direct recapitalization tool be used. They highlight a growing rift between Germany, Holland and Finland (pro bail-in) vs France and Italy (against bail-in).
Ashoka Mody (hat tip EuroIntelligence) proposes a Schuhman compact, i.e., a New Deal for the eurozone involving substantial policy renationalization after recognizing that political union is not attainable. He makes three specific proposals: (i) a new fiscal compact, with responsibility to member states; (ii) sovereign debt compact with a credible “no bailout” regime; and (iii) a banking compact, with downsized banking systems. EuroIntelligence strongly disagrees because of existing vested national interests.
