BlogSpot - Capital outflows and regional imbalances
Good news (continued), or not such good news?
Advanced indictors are providing supporting evidence of a stronger recovery in the euro area (see the FT for example). Francesco Papadia (hat-tip EuroIntelligence) asks whether the ECB's asset quality review and stress tests have been contributing to the recently observed improvement in credit flows, and falls in commercial interest rates. These new data are leading analysts to revise their projections. For example, Citibank seeing growth momentum in forecast revisions moving in favor of the euro area and Japan, reflecting stimulus from loosening monetary policy and weakening exchange rates, and away from prior outperformers. Barclays sees a net positive impact of recent developments (plunge in oil prices, dollar surge, and much easier monetary policy).
However, looking at longer term prospects, pessimism appears to predominate. Dan Davis (the long and short) presents a rather pessimistic view of economic prospects, suggesting that secular stagnation has prevailed over the last 30 years—what is new is that growth is slowing down, but the normal policy levers are unable to speed it up again, with investment capital, instead of circulating round the economy, gets stuck and starts to pile up somewhere, despite price signals telling it that it ought to be chasing new investments. Karl Whelan, drawing on the Finnish example, reflects on the long-term challenges for the eurozone: the fall in the working-age to total population ratio, the secular decline in labour productivity growth, with pessimistic implications: that structural reforms will not help much for the euro-zone generally, and that poor demographics and poor productivity could be the new normal for Europe.Tyler Durden (ZeroHedge), based on evidence that global monetary easing was followed by collapsing world trade growth (see another Zero Hedge entry), even with prices falling over the past three to four years, because of two key drivers—demographics and lower productivity growth.
Institutional limitations of the eurozone contribute to these limitations. Ashoka Mody (Bruegel) notes that the incomplete nature of the monetary union led deep and persistent fiscal austerity to become the norm, hurting growth and undermining the objective of lowering the debt burden. The ECB’s safety net for insolvent or near-insolvent banks and sovereigns, in effect, substituted for the absent fiscal union and drew the central bank into the political process. Mario Mariniello, André Sapir and Alessio Terzi (Bruegel) reflect on the role of the single market as a response to Europe’s economic troubles, and suggest to be moderately optimistic on potential impacts, because (1) barriers continue to prevail in the EU; (2) ‘complementary policies’ to support the single market were not, or were insufficiently, put in place; (3) the single market project has not sufficiently been framed as a key part of the process of creative destruction that Europe needs to embrace to successfully modernize its economy.
QE and its side effects: capital outflows
Large capital outflows have characterized the euro area recently, with big investors shifting out of dollar and euro assets in search for yield, as reported by Tommy Stubbington (in the WSJ). With no official data out yet on outflow, Les Echos and the Wall Street Journal (hat-tip EuroIntelligence) report that in Q3 the pace of net outflows had already intensified, reaching the order of magnitude of €50bn, a level that according to one of the analysts may have persisted in Q4 and Q1, somehow balanced by equity inflows. One of the main drivers behind the net outflows is believed to be non-eurozone central banks. China has given up reserve accumulation as an independent policy goal, while Russia is current drawing down foreign reserves.
Mitigating effects could however be at play. For Anatole Kaletsky (Project Syndicate), outflows could be mitigated if a more competitive euro generates a solid recovery in Europe and attract foreign investors.The ECB's QE has spillover effects, with currencies in the Euro periphery—for example, wih Sweden's Riksbank lowering rates and introducing its own QE program. Greg Ip (Wall Street Journal) argues that, on a global level, the exchange rate effects will globally all cancel each out, leaving a net global positive of lower interest rates. Looking specifically at eurozone QE, Karl Whelan (in Bull Market) looks at the positive impact of QE on the fiscal situation, from both interest payments from the central bank and from lower interest rates on new government bond issues (Eric Lonergan estimates the impact for Italy as a fall in the interest bill by 30% and in the budget deficit by 50%). Whelan suggests that it will be close to zero (with reference to Bruegel’s QE manual) because of its small size (only 6% of GDP when taking into account the average premium on bonds bought by the ECB compared to 25% of GDP in the US), of the capital key weighted purchases, and the low current bond yields.
The dollar surge is the other side of the same coin—reviewed by Jérémie Cohen-Setton, in a Bruegel BlogSpot and well documented by Matt O’Brien, Steve Englander, and Menzie Chinn who all note how quickly and how large has been the increase. The impact on the US depends on the reasons driving the exchange rate adjustment: if it is expansionary monetary policy in Europe (Scott Sumner), then it would be positive for the US, if it is driven by a depressed view of Europe than it would not (Paul Krugman).
And regional rebalancing?
Daniel Gros and Cinzia Alcidi (CEPS) look at two groups of European countries, which experienced a sudden stop after the outbreak of the global financial crisis—the periphery eurozone countries, and four newer EU Member States with exchange rates pegged to the euro. Their main finding is that the adjustment was quicker outside the eurozone than inside, because of buffers available to insiders that reduced the pressure for a quick adjustment, and that the ‘short and sharp’ correction approach is preferable in terms of macroeconomic outcome. Eric Bartelsman, Filippo di Mauro, Ettore Dorrucci, in a VoxEU article, argue that structural reforms are sill needed to achieve regional rebalancing—suggesting that policies should focus more on micro-behavior. They find evidence that credit and labor is actually being reallocated towards the most productive use following the crisis, with structural policies generating ‘cleansing effects’. Tatiana Cesaroni and Roberta de Santis (CEPS) find that an issue with current account dispersion within EU member states have not been accompanied by a significant growth process that is able to stimulate a long-run rebalancing. They provide evidence that the business cycle has played a growing role over time, whereas the role of competiveness seems to have diminished.
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