European economic issues and Paris attacks... any consequences to fear?
Seeking consensus on European economic issues…
Economists at Vox EU are seeking to form a “consensus narrative” about the origins of the euro crisis—to provide clear grounds for policies, beyond the vested national interests for other narratives (Paul Krugman). They argue that the crisis was a “sudden stop” crisis, in which vast capital flows into peripheral economies came to an abrupt halt, with fiscal concerns a consequence. The VoxEu economists write further that eurozone membership acted as a crisis amplifier, made worse by poor crisis management.
The context: sluggish growth and monetary policy. Eurostat's Q3 flash estimate showed sluggish growth in the eurozone economy - 0.3 percent q/q, down from 0.4 percent in the second quarter, associated with a contraction in industrial production in September. This highlights the impact of the slowdown in emerging markets on the eurozone and raises the prospect of more aggressive monetary easing from the ECB. Signs point to an expansion of quantitative easing (QE), to address lackluster inflation, the modest recovery, and risks of de-anchored inflation expectations (see Mario Draghi).
Implementing fiscal policy at the regional level: the limited effectiveness of the European Semester. The EC warned three countries over budget. In its assessment for 2016, the European Commission warned on Tuesday that Italy, Austria and Lithuania are at risk of SGP non-compliance. Spain was also urged to revise its plan. Zsolt Darvas and Alvaro Leandro (Bruegel) write that the Semester is not very effective due to the difficult economic policy coordination in the EU according to: (i) recommendations are not really implemented (see their briefing paper and the work of Servaas Deroose and Jörn Griesse), (ii) the articulation between euro-area recommendations and country-specific recommendations is poor, with some inconsistencies, and (iii) there are limited ways to improve the effectiveness of the Semester—as national policymakers remain accountable to national parliaments and focus on national interests.
What is happening to investment? The impact of QE. Analysts, faced with low investment rates in the eurozone, are looking for causes, among which QE. Jérémie Cohen-Setton (Bruegel) reviewed those in a recent blogspot (see also FreeExchange). First, monetary policy may have created a preference for financial assets (share buybacks over investment) according to Michael Spence and Kevin Warsh, which are shorter-term commitments write (debated by Summers and Joseph Gagnon, as QE raised equity prices and should have favored investment, ceteris paribus). For Brad Delong, the impact may be through lower financial volatility, while Robert Waldmann relates this to the negative correlation between duration risk in long term Treasuries and the risk in fixed capital. Not all agree with this narrative, with Paul Krugman and Larry Summers reminding that basic economics suggests that investment responds to capital cost. Brad Delong writes that weakness in overall investment is due to weakness in housing investment, while business investment is normal.
Is delayed and partial bank resolution Europe’s problem? Matthew Klein looks at the evidence and contradicts the idea that banking was a major contributor to the crisis—and Paul Krugman adds that, like in Japan in the 1990s, bank lending is weak because of the liquidity trap not because of banking problems. Klein (FT Alphaville) questions the usual narrative on the role of banks: he finds no real difference with the US in terms of investment spending; nor in terms of tightness of lending standards—but big differences on the demand for loans.
Attacks in Paris – Assessing the Economic Impact
The impact on France will be through fiscal and confidence channels. ECB officials warned that the attacks on Paris could harm Europe's fragile recovery (see Henrik Müller in Spiegel) and "compound" the difficulties the euro area already faced. For Deutsche Bank, Reuters, and Citi, the tourist industry may be temporarily affected but the overall direct economic impact is likely to be marginal. Barclays looks at various metrics to assess the economic ramifications—from French sectoral unions highlighting a significant drop in activity in Paris, details on the vulnerable services sector, to economic confidence shocks tracked with business survey. Dominique Seux (Les Echos, hat-tip EuroIntelligence) notes that this time it could be different—while in the past, effects were limited and short term—if fear persists, it will agents’ consumption patterns.
“The security pact prevails over the stability pact”. President Hollande announced expansion of funding for national security and prisons (8,500 new jobs) and that planned defence cuts would be halted (saving 9,200 jobs) (Les Echos), though it will only create a limited fiscal gap (EuroIntelligence) with a risk of breaching the SGP spending limits.
A limited confidence impact. For Citi, household confidence will be affected but the impact will be balanced with extra spending on policing, private security and military intervention.
The political economy implications, in France and in Europe. For Deutsche Bank Francois Hollande’s decision to “go to war” with IS and to present himself as a strong leader may bolster his standing, though the attacks may have raised the symbolic importance of a National Front victory in the regional elections in December (which would be a historic first). Citi also notes that the attacks prompt some re-thinking of the migration crisis and a likely tougher stance among individual countries.
The Short View… Tyler Durden (ZeroHedge), looking at data from the Baltic Dry that shows a 70% collapse in container freight rates (to all-time record lows) when seasonality is generally supportive (Reuters)—an alarm signal for global trade (Acting-Man's Pater Tenebrarum)?
