BlogSpot - January 24th, 2014
Is the World getting better?
The world economy seems to be turning a corner, and the mood at Davos was definitely more positive, as reported for FT Alphaville. A decisive factor, according to UBS, is the absence of austerity in the global economy. Joseph Stiglitz, in Project Syndicate, present a pessimistic view of the economic situation, an “advanced malaise” to which 2014 will bring little relief in Europe, with the US being a brighter spot though with long-term unemployment as a new problem.
Europe: more turbulence or heading out in 2014?
EuroIntelligence reports the additional sign of economic recovery in the eurozone, especially the latest business confidence and the Markit data. The debate is focusing on risks to long-term growth, and FreeExchange stresses that a chronic growth crisis is at play in Europe, despite the recent relative euphoria in bond markets.
Jacob Funk Kirkegaard, in Peterson Institute, believes that the relative tranquility of 2013 will last into 2014, with sees little risks from the political side (no major national elections, and minor risks from the European elections and the two independence referendums in Scotland and Catalonia). Nicolas Veron, in a Peterson Institute publication, sees a number of reasons for a turbulent 2014 for Europe: (i) the risks of unrecognized weaknesses in some banks, possibly requiring public intervention and restructuring, that could be revealed by the banking union; (ii) the incompleteness of the banking union that could reawaken investors' worries; (iii) the combination of the delay in bank clean-up, fiscal austerity, and the ECB's continued reluctance to engage in unconventional monetary policies (see on this James Hamilton post in EconoMonitor), keeping growth anaemic. Ibrahim Gassambe, on Roubini, writes that in 2014, cyclical uncertainty will dissolve but structural uncertainy will remain. For the eurozone, he sees ECB policy—including the asset quality review as the major catalyst.
In a Project Syndicate article, Michael Spence also stresses that the current recovery is incomplete, with a need for more convergence in unit labor costs and reforms targeting structural adaptability in Europe and persistent underinvestment in the public sector in the US, in the context of growth patterns resulting in a dramatic rise in inequality, and FreeExchange notes that inequality was a major issue at the Davos World Economic Forum. He calls for sustainable patterns of equitable and inclusive growth.
What about policies? Guntram Wolff (Bruegel) argues that the key to solving the risk of “secular stagnation” in Europe is better investment conditions and a better integrated financial system, rather than monetary policy. Kirkegaard stresses that what matters is implementation of the existing proposals. He sees the stress tests as the most significant economic event to expect in 2014. Among the policy actions, the banking union comes up on top of the 2014 agenda. Silvia Merler and Guntram Wolff, in VoxEU, outlines the transition to the new steady state, involving a comprehensive balance sheet assessment, new rules regarding recapitalization, restructuring, and resolution, and the determination of how recapitalisation costs are distributed across taxpayers in different European nations.
Roberto Tamborini, in EconoMonitor, reinforces that point arguing that 2014 may be the time for final decisions for the future of the EMU, i.e., decide whether they really wish the EMU reforms that are necessary to give the euro a future—with the urgent need for an effective system of protection and stabilization of large economic and financial boom-bust cycle articulated at the national and super national levels. Katinka Barysch (Project Syndicate) criticizes recent reforms as being overly focused on large-scale top-down reforms and makes the case for small steps guided by market mechanisms. Barysch argues that current proposals are backward-looking, addressing imbalances that are already being resolved while future problems will be of a different kind.
Nouriel Roubini, with Brunello Rosa, write that the ECB is gearing towards more unconventional policies in 2014, including a negative deposit rate (see a previous Warning Signal blogspot) and outright quantitative easing (QE). This is on the back of growing concerns about deflationary risks and a strong euro.
Deflationary risks and options for monetary policy
Eurostat’s preliminary estimates for 2013 inflation figures reignited the debate on deflationary risk in the eurozone, and EuroIntelligence provides more details on the last numbers. Deflationary risks are discussed in a series of blog entries on FreeExchange.
Paul de Grauwe insists that debt-deflation dynamics are at work in the eurozone, especially in countries with the highest debt levels and criticizes the ECB for staying on the sidelines, and not providing the liquidity that would prevent deflation. Demosthenes Tambakis showed that deflation risk increases in the presence of zero-lower-bound events, and therefore are greater in the eurozone today. Guillermo Calvo adds that risk dynamics between emerging markets and the eurozone, and “flights to quality,” may strengthen the euro and further price deflation.
Kevin O’Rourke, looking back at history, argues that an adjustment strategy based on the expectation that already over-indebted countries will delever in an environment of falling prices is doomed to failure, especially if “internal devaluation” is replaced by euro-zone-wide deflation, with even higher costs (higher real wages and unemployment, and a negative impact on the real value of private as well as public debt).
Andrea Ferrero looks at the likely options to be taken by the ECB and uses the US experience as a good guide. Discarding the possibility of quantitative easing, he sees some reluctance in pushing more precise forms of forward guidance than the current ones, and views negative interest rates on reserves as an alternative. A more radical approach would be a commitment to allow for higher inflation by exactly the same amount that compensates for the currently projected undershootings.
By Niklas Rodewig
