Global easing – Global risks? Which consequences from loose monetary policy ?
Inflation: NO. Financial data point to lowflation and secular stagnation. For William R. Cline‘s (Peterson Institute), the increase in banks’ excess reserves has led to the increase in the Fed’s balance sheet but has not translated into increased money supply after the Great Recession. Paul Krugman relates this to the predictions of Hicks-type modeling, i.e. that in a liquidity trap the rise in the monetary base is not inflationary at all. Interest rates, despite a recent bounce, are still historically low. German real rates are even strongly negative when looking at yields on index bonds. Guntram Wolff (Bruegel) agrees. Low inflation from better policy management and falling long-term growth prospects are the drivers of low returns on German savings, not ECB policy. The cause of secular stagnation is to be found in demographic developments, increasing capital stocks, the absence of reform and the weak economic outlook in the Eurozone (even predating the crisis, as highlighted in the IMF WEO). Once again, structural reforms are recommended to boost demand, i.e. public investment and reduced tax on low-income households. Several economists (Peter Bofinger, Kenneth Rogoff, Lawrence Summers, Willem Buiter) call for a cashless society to face the reduced influence of Central Banks. It would force people to use debit card linked to a government controlled bank account and raising either interest on account holdings or tax would be an effective tool.
Inequality: MAYBE, SOME. As reported by the WSJ, Stiglitz noted that the Fed’s attempt to stimulate economic growth has contributed to inequality but Robert Solow argues that the Fed just behaved as expected, promoting investment while the tax system has to be blamed for higher inequalities. Mario Draghi mentioned distribution as a collateral consequence of QE: with low rates penalizing savers and rising asset prices benefiting the wealthy. Draghi argues however that monetary policy inaction also has distributional effects, positive as borrowers have a higher propensity to consume and invest than lenders.
Financial instability and asset bubbles: LIKELY. Tyler Durden (Zerohedge) reminds us that both conventional and unconventional monetary policies have proven ineffective to smooth out the business cycle but have inflated asset bubbles: in the US, first the housing bubble and now the equity and fixed income bubles; in Japan, the “Kuroda Zone;” in China, real estate bubble creation; and asset inflation in the eurozone. Durden argues that the world CBs have set the stage for a new spectacular collapse while creating a worldwide deflationary supply glut. Martin Feldstein (Project Syndicate) explains the mechanism resulting from very low interest rates. Investors are taking excessive risks to achieve higher current yields, especially when bound by return obligations (e.g., insurance contracts). This drives up the prices of all long-term bonds and emerging market debts, and extended credit to lower-quality borrowers. A liquidity mismatch follows, since bonds are mostly held in bond mutual funds or exchange-traded funds that actually do not have full liquidity in practice. With weak macroprudential policies, a disorderly unwinding of interest rates is likely to destabilize the system. The IMF warns about financial market risks (and low market liquidity) in its recent GFSR. Evans advises the Fed to wait before rising rate, and make sure it achieves its 2% price target. Alicia Garci-Herrero (Bruegel) expresses similar concerns about additional easing in China. Given China’s deteriorated fiscal finances, lowering the cost of funding will lead to high credit risk and foster financial fragilities.
In the case of the Eurozone, Benoît Coeuré warns about asset bubble formation and highlights te need for investments in productive sectors to avoid bubbles. Mario Draghi insists that in many countries low interest rates have actually facilitated balance sheet adjustment by stabilizing debt dynamics and deleveraging banks’ balance sheets, thus rendering normalization easier in the medium-term. He notes that monetary policy decisions have been taken in a broader policy framework designed to mitigate financial stability concerns.
Risk-sharing in the eurozone. H. Benink and H. Huizinga fear that the current national risk-sharing scheme used for the ECB in times of QE will be used for the Outright Monetary Transactions program in the future to convince the Germans to get on board. The OTM with national risk-sharing would lead to the inability of some national central banks – that hold 92% of the sovereign bonds through the QE program – to sustain potential losses, especially in a low-growth scenario. Anticipating the next financial crisis, Jeremy Bulow and Paul Lemperer propose a new instrument called an equity recourse note (ERN) that has the same functions as debt in normal time but that is converted when the bank’s share price is below a threshold rather than a regulatory measure of capital. This instrument satisfies banks which prefer bonds over equity, just like contingent convertible bonds would, but avoids the uncertainty about the regulator’s behavior and minimizes abrupt losses.
Trade agreements are booming, WTO still sleeping
The U.S is likely to adopt two trades agreement, namely the Trans-Atlantic Trade and Investment Partnership (TTIP) and the Trans-Pacific Partnership (TPP), reviving the debate about trade gains and agreement-related issues—reviewed by J. Cohen-Setton (Bruegel).
Modeling battle over the net gains assessment. Dani Rodrick reviewed the debate about the likely consequences of the TTIP. Using different models, Joseph François et al. find positive but small GDP effects, while Jeronim Capaldo concludes to a decline in EU GDP. Rodrik reminds us that current trade barriers are already low. In a CEPS report, Patrick Messerlin calls on the TTIP to bring to the fore talks about services regulation convergence. Risks of discriminatory impacts on non-TTIP economies are also a concern. Positive spillovers could mitigate these effects if third-countries align their national regulations to the post-TTIP regulations. Both Brad Delong and Paul Krugman perceive potential gains from the TTP as relatively small but they could be rather large compared to other decisions the US can make.
Free trade agreements (FTAs) as strategic tools. Jiří Šedivý (Project Syndicate) argues that the TTIP would reinforce the trans-Atlantic strategic alliance. Although strongest benefits will come from lowered prices and increased productivity for the U.S. (Peterson Institute), Adam S. Posen also points to the political integration opportunity in the case of the TPP, especially in bringing in emerging countries.
Implementation and regulation as the biggest issues. The list of remaining issues in the implementation of such trade agreements remains long. First, Investor-State Dispute Settlement aiming at protecting firms that invest abroad against unfair treatment by foreign governments is criticized by Gary Clyde Hufbauer (Peterson Institute). Krugman adds that the ISDS procedure could be used to force changes in domestic law. Second, the Council of Economic Advisers fear to put US workers and businesses at a disadvantage. For Lawrence Summers, areas to be fiercely negotiated are those bearing directly on middle-class living standards such as inappropriate producer subsidies. A proposition to change US trade law aims at including currency undervaluation as an unfair subsidy. But Gary Hufbauer from Peterson Institute says that such practice would involve the WTO in solving conflicts and how it would rule is highly uncertain (WSJ). Third, enforceability of the trade agreement is also in question (Timothy B. Lee), as Ezra Klein reminds us with the case of the NAFTA labor and environmental standards.
Marc Lanteigne takes the example of the successful Sino-Swiss trade agreement that proves that IP and labor protection can be enforced. He highly recommends the EU to consider a FTA with China despite the divergence in enthusiasm among its member and current trade disputes with China.
Short view: Continuing Grexit talks… With negotiations taking time and more payments coming up, observers are drawing up catastrophic scenarios—see the Guardian; Anatole Kaletsky (Project Syndicate) for whom Greece is trapped inside the Eurozone and starves it of money; Ashoka Mody (Bruegel) a bit more optimistic in predicting the EZ hold on together; Roger Bootle and Jessica Hinds (Capital Economics) calling for an Iceland-type recovery; M.J. Casey (WSJ) warnings about contagion risks; Edward Hugh looking at the costs of no solution. However, EuroIntelligence notes that creditors are considering a program extension—stay tuned. NEMO provides a useful timeline of key Greek dates until end-June.
