BlogSpot - December 1st, 2014

Commitments and Implementation in the eurozone

European Commission’s Annual Growth survey. In order to support job creation, the European Commission relies on a three-pillar strategy comprising a three-year investment plan of € 315 bn, a strengthening of the Single Market through structural reforms and a pursue of fiscal responsibility (EU Business). The first point echoes Juncker’s plan with the creation of the European Fund for Strategic Investment (Bruegel). Public funds should be used as a buffer to unlock private investors’ mistrust (FT) although Matthew Dalton (Wall Street Journal) doubts it will be enough to close Europe’s investment gap (Claeys and al., Bruegel). The second refers to product market and labour market regulations which the OECD widely recommends the European Union to undertake. Concerning the European regulatory framework, Brussels should assess systematically the incidence of EU legislation on innovation dynamics (CEPS). The third pillar is more contentious in line with Krugman‘s calls for a slower pace of fiscal consolidation while fostering demand-boosting policies (Mainly Macro). The European Commission points out to the remaining macroeconomic imbalances which could harm economic recovery if the eurozone does not manage spillovers (iMF Direct). On the financial forefront, the ECB also stressed downside risks of liquidity stop and re-emergence of sovereign debt sustainability in its Financial Stability Report (Euro Intelligence). These go beyond systemic risks and stem from weak perspectives of growth and macroeconomic balancing.

In its Alert Mechanism Report, the European Commission raises awareness about “the unwinding of imbalances and their related risks in 16 Member States”, notably in France, Italy and Belgium whose budgetary plans will fall under further examination in March, 2015 (Europa). The Joint Employment Report released its GDP growth forecast for 2015 which is expected to reach 1.5% in the EU and 1.1% in the eurozone. Governments’ debt-to-GDP ratios are slowly retreating and might peak next year at 88.3% and 94.8% respectively.

Enderlein-Pisani report on Franco-German investment reforms. The report released by two leading European economists, Henrik Enderlein and Jean Pisani-Ferry, attempts to propose real steps to jumpstart the European economy, and address the lack of boldness for decisive reforms in France and complacency in Germany (as reported by DW). It advocates for supply-side reforms supported both by private and public sectors, as recommended for example in policy papers published by the EPC. The proposed measures include labor market reforms (towards flexicurity in France and greater wage competitiveness, towards more inclusive growth and greater workforce participation in Germany); leaner governments, especially in France. It focuses on investment, with proposals of a minimum threshold for net public investments, complementing the debt brake, to avoid a further reduction in the value of German public assets and a five-year fund for priority projects at the municipal level; while enhancing the allocation of investments in France. The report also proposes the creation of a euro area fund to boost public investment by 5% over three years, in priority areas and in support of long-term growth and innovation. Finally the report proposes to create an “economic Schengen”, fostering economic integration in priority areas (energy, digital, education), and policy convergence in the areas of minimum wage standards, pensions, and education. It rejects a split in policy mix between Germany undertaking fiscal stimulus and France engaging into structural reforms (Euro Intelligence).

However the long-term recommendations may be of little help in the short term to boost aggregate demand and support European growth recovery. The effectiveness of reform clusters may only be reached if a sound European regulatory and governance architecture is put in place (Delors Institute). Daniel Gros (CEPS) argues that with limited public resources, these should aim at supporting consumption rather than financing infrastructure investments—for more immediate growth effects.

European Banking Union on track. With the two-fold institutions of the Single Supervisory Mechanism (SSM) and Single Resolution Mechanism (SRM), the ECB is entrusted with new supervisory tasks over the banking sector (ECB). As Silvia Merler notes, the SSM designs the common European rulebook that the SRM implements. Because of the sovereign-bank interconnectedness and disproportionate amount of sovereign bonds in banks’ capital positions, there are rising calls for capital buffers and stricter rules on banks’ exposure to foster risk diversification, similar to FED’s concerns about the necessity of further quantitative liquidity regulation (FED). That would go beyond leverage ratios and risk-based measures of capital adequacy (BoE). Enhancing the European macro-prudential toolkit would strengthen the Single Market through higher financial integration (Vitor Constancio, BIS). Moreover, the rise of shadow banking stands as a major threat to European and global financial stability (Peterson Institute).

Beyond the EU, policies aiming at strengthening global trade could be an adequate candidate to deliver extra growth (Barbara Kotchwar for Peterson Institute), with some measures yielding potential additional income of up to $2 trillion (according to Cathleen Cimino in Peterson Institute). Michael Boskin (Project Syndicate) points at three opportunities stemming from trade liberalization that could kickstart global growth: reductions of tariffs and non-tariff barriers, protections of intellectual property and harmonization of regulation. Unfortunately, according to the WTO, G-20 economies relied on restrictive trade measures from 2008 onwards (though less than in the 1930s), though the FT notes that tariff liberalization measures far exceeded the number of tariff increases during the 2008-2013 period. But Boz and al. highlight the slowdown in global trade (Vox EU). The CEPR’s 16th Global Trade Alert Report is alarmist, emphasizing the emergence of a “global trade disorder” due to rising protectionism (CEPR).

Lessons from Abenomics as a warning to eurozone initiatives

Preliminary assessments of Abenomics inform the European ongoing debate on the right policy mix to bolster economic recovery in times of deflation. For Paul Krugman, the Japanese example is a reminder of the pressing risk associated with the disanchoring of inflation expectations (ECB), and calls for demand-side policies rather than structural reforms. In the short-term, the latter can be harmful to growth, because of negative effects on aggregate demand. As such, Krugman welcomes the delay in the consumption tax hike (FT). Vitor Gaspar (iMF Direct) is less black-and-white and sees smart fiscal policy as complementary to structural reforms to support job creation—with fiscal policy assuring a fair distribution of deficit reductions’ efforts and minimizing short-term costs.

The policy debate remains open in Europe with a German narrative focused on supply-side reforms. Some argue these will bear fruits too late and propose growth-enhancing policies targeted at bolstering private investment and alleviating the credit crunch. Wolfgang Schäuble’s plan to spend an additional €10 billion on public investment in 2016-2018 is too little too late (Euro Intelligence).

On monetary policy, Wolff (Bruegel) highlights two lessons the Euro Area could take away from the BoJ’s experience. First, getting the public move from a deflation to an inflation mindset requires Central Banks to engage into a sustained commitment regarding accommodative monetary policy, supported by early measures on banking reform and productivity enhancing structural reforms. The second lesson is more pessimistic, as Wolff argues that while the BoJ still has the political leeway to take bold decisions, this is hardly to be the case for the ECB. Mario Draghi announced the ECB’s readiness to expand its balance sheet further if needed, though this requires solid regulatory tools (Free Exchange). Germany’s skepticism about the soundness of ECB’s dual implementation of QE and credit easing might undermine its credibility according to Marcel Fratzcher (Project Syndicate).

Rise of radical-left parties and associated Keynesian policies: the case of Podemos

Barely 10 months after its creation, the new Spanish radical-left party Podemos leads the polls and could claim around 28.3% of the votes in the elections next year (IBTimes). According to Wolfgang Münchau, radical parties are emerging all over Europe as a response to center-left and center-right established parties being unable to halt Europe’s drifting into recession. According to Munchau, Podemos is the only party that offers a consistent approach to post-crisis economic management. According to El Périodico, the party’s economic program adopts a neokeynesian stance, supporting strong government intervention, boost of internal demand, and debt restructuring within the eurozone (Nacho Alvarez). Wolfgang Münchau concurs it is logically inconsistent for member states of a monetary union not to restructure their debt while being stuck into secular stagnation. Some economists criticize Podemos’ economic program for being unrealistic and poorly thought through (Eurointelligence), lacking a coherent vision for the post-debt restructuring period and possible inability to implement Keynesian stimulus (Wolfgang Münchau).