Debates within Europe
Governments’ Deficit and Debt: Who’s Right?
Moving towards permanent primary surpluses—the UK case. George Osborne plans to enshrine permanent budget surpluses in law (see his Mansion House speech). For academics (such as Piketty and Ha-Joon Chang), this would shift the burden of debt from the government to households, with risks of a personal debt crisis. Martin Wolf (FT) also argues that focusing on public debt alone is mistaken as it ignores the asset side of the balance sheet altogether. Moreover, larger fiscal surpluses would induce lower interest rates, higher private debt and more financial instability. Simon Wren-Lewis (Mainly Macro) and Geoff Tily (Class) agree that outlawing deficits makes no economic sense. As Gemma Tetlow (Institute for Fiscal Studies) puts it, unfortunately, economic theory does not provide an answer to what the right level of borrowing for a country is. For a given level of taxation, lower borrowing requires lower spending. Yet, lower borrowing restore fiscal buffers.
Debt reduction and growth in the eurozone. In a CEPR paper (VoxEU), a group of well-known economists reckon that the Eurozone should deal with debt reduction to revive investment and consumption growth, and prevent a new crisis. Yet, not all countries are in the same boat, as analyzed by J. Ostry, A. Ghosh and R. Espinoza (IMF, see our previous BlogSpot). The situation in Greece, Cyprus and Italy is contrasted with that of Norway, Germany and the UK, where fiscal space is ample (Moody) and borrowing costs is low. For Wren-Lewis, timing is important and policymakers can certainly afford to wait until interest rates have begun to rise, so that monetary policy can offset the impact of any subsequent fiscal consolidation. Bryan Taylor stresses that countries have long lived with high debt ratios—what matters is whether the increase in debt ratio is short-term (due to war or economy fluctuations) or secular (due to unfunded increases in government spending). Life After Debt, a US report, lists potential side-effects from the Federal debt reduction such as the end of Treasury securities and a shift in the way to conduct monetary policy. Joseph Stiglitz and Martin Guzman (Project Syndicate) call for an international rule of law for resolving sovereign defaults.
Is Quantitative Easing Working in Eurozone?
The OMT is legal. Legality of the ECB’s 2012 bond-buying program won the backing of the European Union’s highest court (ECJ), expanding ECB’s crisis-fighting arsenal. The ECJ was responding to a legal action by a 35,000-group from Germany, who had challenged the bond-buying scheme. Judges said in a ruling that the Outright Monetary Transactions program (OMT) does not exceed the powers of the ECB and does not represent a monetary financing of fiscal deficits. Some observers are of the view that having the OMT ready without impediments is timely, making it easier for the ECB to intervene should the Greek crisis escalate.
Disputed views on the effectiveness of the ECB’s QE. Inflation for the Euro Area registered at 0.3% Y/Y in May (up from -0.6% Y/Y in January) and GDP growth rate for Q1 registered +1% Y/Y (compared with +0.8% Y/Y in Q3 2014). The ECB, reflected by Ewald Nowotny, believes that its asset purchase program is starting to bear fruit by contributing to a "growth-friendly” environment (reported by Brecorder). In a late 2014 post, John Muellbauer (VoxEU) argued that the QE would be less effective in the euro zone than in the US because the total liquid asset holdings of households were far larger than total household debt (notably in France and in Germany), so much so that lower policy rates would translate into lower deposit rates and reduce total household spending.
Volatility and pre-QE interest rates. After having reached a lower level in April, long-term interest rates on government bonds are starting to pick up, with the recent German raise in yield posing question to the efficiency of the QE. Daniel Gros considers this is a failure of the ECB’s bond-buying program as interest rates have returned, in real terms, to pre-QE levels. He stresses that measuring the success of a policy according to expected inflation in 2020-2025 is not reliable. Furthermore, QE has been associated with greater volatility. Mario Draghi insists that investors should get used to periods of higher volatility. Yoram Lustig (FT) argues that QE is responsible for the lack of liquidity winding-up on violent and quick movements on markets, compounding the Greek effect on markets (EuroIntelligence). For Draghi, the recent volatility is due to A/ improvement in the perspectives of growth, B/ higher inflation expectations, C/ technical conditions present in the markets like (1) one-directional investments into long-term maturities (2) strong supply pressure, (3) shorter-dated German Bunds becoming eligible (4) volatility generating further volatility and further selling, (5) poor market liquidity. QE also puts pressure on some business models (Euronews) like insurance companies and pension funds. For Allan Meltzer (Intereconomics), QE also fails in addressing the key issue of real wages adjustment.
The Short View—Commission President Juncker will present a second report on the future of EMU (see first report here). While Jacques Delors Institute pushes for it, EUinside reported that we could expect something as the banking union to be completed.
