Archive for the ‘EMU’ Category
Ashoka Mody has a new Bruegel essay proposing a “Schuman compact” for the Euro area, available here.
The financial architecture of the Eurozone is still a mess. One possible improvement might be a wave of cross-border bank takeovers and mergers. Such a change might make the Eurozone less fragile since country-specific economic shocks would not have a two-way negative-feedback through the balance sheet of country-specific banks. This change would also kill the potential for country-specific deposit runs. The bank regulatory authorities in the U.S.A. (FDIC and Federal Reserve) often arrange mergers and takeovers of troubled banks to snuff out liquidity/solvency crises at individual banks and/or dampen regional shocks. J.P. Morgan was encouraged to take over Bear Stearns and Washington Mutual by the regulators for exactly these reasons. Now, quite appropriately, J.P. Morgan is responsible for the “legacy liability” issues of these two absorbed banks, and it looks like the final bill for J.P. Morgan could be over $10 billion. J.P. Morgan is the legal successor and a change of ownership does not eliminate the liability, even if (as in this case) the regulator gave you a Best Boy in Class ribbon when you agreed to the takeovers. The J.P. Morgan case is in a foreign jurisdiction, but nonetheless this case will have knock-on effects for the Eurozone. The J.P. Morgan case makes it less likely that there will be any takeovers of troubled or formerly-troubled Irish banks.
It has always struck me that the first order consequence of making it easier for firms to fire people in the middle of a depression would be that…firms would fire more people. And it has never struck me that this would be desirable.
Now Gauti Eggertsson, Andrea Ferrero and Andrea Raffo have a new paper pointing out that at the zero lower bound, where monetary policy cannot offset the deflationary impact of structural reforms that would otherwise be desirable (lowering mark-ups in product and labour markets), such reforms can be contractionary (by generating expectations of deflation and raising real interest rates).
All of which seems obvious once you think about it, but it needed someone to point it out. And this is a problem for a continent whose leaders refuse to take the demand side of the economy seriously, and are hoping that “structural reforms” will obviate the need for them to rethink their macroeconomic strategy.
Another chance for Paul Krugman to cite St Agustin!
“Thailand without the baht” is a useful way of thinking about the Irish economy’s boom, bust, and subsequent flat-lining, so it’s great to see that Paul Krugman is about to get his teeth stuck into the Asia-Euro comparison.
Some people argued in 1997/1998 that the crisis showed that the entire East Asian growth model was flawed. Whatever the benefits or costs of that model may have been, the subsequent rebound showed that these economies were still capable of delivering long run growth once their short run macro problems had been resolved. Seen from the inside the Irish growth model seems pretty rickety, but respectable if unexciting growth rates of the sort you see in countries close to the technological frontier should be attainable in the future once our own short run macro problems, and those of the Eurozone as a whole, have been resolved. Unfortunately this doesn’t seem to be on the horizon right now, which is why the “default and devalue” scenario has to be an option now in Greece, and may eventually come onto the policy agenda in other Eurozone periphery countries as well. The problem with the “short run” is that it can continue for an awfully long time unless corrective action is taken.
Jeff Frankel has a terrific piece here on the unsatisfactory way in which recessions and recoveries are called in Europe.
The current European definition of a recession (two successive quarters of declining GDP) is particularly unsuitable in Ireland, given its dodgy and volatile GDP statistics — looking at a broader range of indicators over a longer period of time would surely make more sense here.
There is an additional cost to the two-quarter rule of thumb in the Irish and Eurozone context: it implies that Ireland is periodically proclaimed to be out of recession. This then allows Eurozone politicians and central bankers to defend the status quo monetary and fiscal policies prolonging the economic crisis in Ireland and elsewhere. (And to express “surprise” when Ireland tips into recession “again”, despite its model pupil status.)
Update: the CEPR’s Euro area business cycle dating committee does not use the “two-quarter GDP decline” rule of thumb. Details of their methodology are available here.
We know that rising unemployment is not something that will make the EU admit that their current macroeconomic policy mix isn’t working.
We know that two successive years of GDP contraction is not something that will make them admit it either. Even though some of them denied at the time that this could be a consequence of austerity.
Will spiralling debt/GDP ratios do the trick? This is, after all, the number they have been fixated on since 2010, and the figures show that, even on its own terms, the current strategy has not been working.
This is where dodgy GDP forecasting becomes so pernicious: no matter how much of a basket case the Eurozone becomes, over-optimistic forecasts — notice how good we expect 2014 will be!! — will always make it possible for discredited politicians, central bankers and eurocrats to cling on to the hope that good times are just around the corner. The risk is that they will wake up one day and find that it is too late to change course, both for themselves and for the euro.
My thanks to commenter Eamonn Moran who pointed me to this paper recently published by the Central Bank, and which deserves a wide readership, especially among advocates of “internal devaluation” strategies across the Eurozone periphery. The Irish figures are very striking, not just in terms of how few firms have cut wages here, but of the reasons why.
There are costs and benefits to everything, even emigration at a time of economic crisis. We Irish have probably gotten so used to (silently) thanking our lucky stars that our young are not hanging around at home being unemployed (or at least, not to the same extent as the young in the Mediterranean), that we may have forgotten this. Indeed, I had forgotten that I wrote this back in 2010. But now Paul Krugman points us to this post (and see also this one) which brings up the issue, and it is worth thinking about it seriously.
Long run GDP and tax revenue may not suffer that much if people return home eventually, especially if they bring home new skills and contacts, but what if funding crises happen before then? And are we perhaps too optimistic about the prospects for return migration? My generation came home in droves because of the 1990s boom, but that sort of growth is obviously never going to be replicated: you can only catch up on the technological frontier once. And as I pointed out in that earlier post, there is scope for negative feedback loops here, related to the overhang of government debt.
All in all, another reason to think that debt restructuring is going to eventually have to take place around the Eurozone periphery.
(H/T Alan Taylor who suggested the title of the post. That is a clue as to what it refers to by the way.)
Worth a look, Breugel’s assessment of the programmes in Greece and Ireland in particular, and the differential roles and internal tensions played by the individual members of the Troika, particularly the Commission. The large effects these programmes are having on unemployment is a key feature of the report.
A holy trinity — or perhaps a troika? — of beliefs has guided policy since 2010. These are that austerity is expansionary; that the sky will fall in if ever the debt to GDP ratio exceeds 90%; and that the way to do austerity is to cut expenditure rather than raise taxes.
All of which is very convenient if what you really want to do is shrink the state.
We know how well the first two nostrums have performed when confronted with empirical evidence, so you might think that people would be just a wee bit cautious about stating the third as gospel truth. But no, here is Mario Draghi:
First, fiscal consolidation should be based on reductions in current expenditure rather than increases in taxes. Unfortunately, many of the fiscal consolidation measures were implemented in an emergency situation, with most governments choosing the simplest route, which was to raise taxes. And here we are talking about raising taxes in an area of the world where taxes are already very high, so it is no wonder that this had a contractionary effect.
Paul Krugman helpfully reminds us where this belief came from, and what happened next. The ECB is constantly telling us that it has a narrowly restricted mandate, with its primary concern being inflation. In that case, then surely the least that we are entitled to expect is that it keeps its views about the composition of fiscal adjustments to itself?
The Eurozone banking system is not working properly due to fragmentation between core and peripheral banking systems. In a recent speech, the president of the ECB, Mario Draghi, has acknowledged this, but argues that fixing this problem is someone else’s responsibility. The ECB has the tools to address this crucial flaw in the Eurozone system, and over the medium term horizon there is no other Eurozone institution that can. The ECB should use the tools available to fix this market fragmentation, in particular, the ECB should engage in aggressive, long-term asset refinancing on sufficiently generous terms to encourage bank participation. (more…)
It has been evident for quite some time that citizens right across Europe are losing faith in the European Union, and the fact is making the headlines today. If the Euro experiment needs meaningful banking union, including some element of fiscal union, and probably other “deepening” reforms as well in order to survive, and if citizens are becoming increasingly hostile to “Europe”, meaning that such reforms are politically impossible, then the Euro may be doomed in the long run. In the meantime the never-ending Eurozone crisis, caused by a flawed currency, a dysfunctional central bank, and a perverse macroeconomic policy response, is dragging the entire European project down with it.
Update: bang on cue, Spain’s unemployment rate has reached 27 percent this morning. Solving the periphery’s economic problems rather than saving the Euro really has to become the continent’s top priority. Apart from anything else, you won’t be able to do the latter if you don’t do the former.
Rarely have statistics been misused so much for political purposes as when recently the ECB published the results of a survey of household wealth in the Eurozone countries.
Thus begins a new column by Paul De Grauwe and Yuemei Ji, which points out, inter alia, that the median household wealth statistics currently being used by some German economists and commentators to justify future wealth grabs in the Eurozone periphery are in fact telling us something important about German inequality.
But it gets worse. Tim Worstall (H/T Eurointelligence) quotes the ECB report as follows:
2.2.3 VOLUNTARY PRIVATE PENSIONS/WHOLE LIFE INSURANCE
This section shows how households save for retirement using voluntary private pension
plans and/or whole life insurance contracts. Public pensions and occupational pension plans
are not considered in this report, as the value of some public pensions and occupational pension plans can be difficult for households to evaluate. Cross-country comparisons are challenging in the sense that institutional arrangements across countries with respect to the different modes of retirement savings, such as voluntary private versus public or occupational, can be quite substantial. A deeper analysis of these differences falls outside the scope of this report.
As Worstall says, this means that many households’ major asset is being excluded, essentially on the grounds that including them would be really rather difficult.
Time for the report to be consigned to the dustbin, surely, and for those people currently abusing it to spend even five minutes or so reflecting on what the likely political impact would be if their proposals were implemented.
George Soros’ recent speech on the eurozone is available here.
Simon Wren-Lewis is puzzled here.
In a must-read article, Chris Pissarides states that “far from the currency bloc acting as a partnership of equals, it is a disjointed group of countries where the national interests of the big nations stand higher than the interests of the whole.”
This sums up perfectly where the European project is today. Indeed, there isn’t even solidarity among the smaller countries, as Malta and Luxembourg seek to distance themselves from Cyprus, reminding us of many similar protestations by individual PIIGS in the past, Ireland included. Not that it did any of them any good.
Was it not bizarre to see so many anti-German posters in Nicosia last week, when by all accounts it was the Cypriot President (among others) who wanted to see small depositors hit? Actually, no, it wasn’t. We have seen several statements by German politicians saying that the Cypriot business model is dead, and I’m sorry, but irrespective of the rights and wrongs of the issue this is simply unacceptable. The IMF has the right, and duty, to opine on such matters. So does the ECB, which is supposed to care about financial stability, whatever about how it behaves in practice. Perhaps one could find a rationale for the Commission, or maybe even the Eurogroup, to express an opinion on matters such as this. But an individual member state? Formally speaking, and in any club such formalities matter, it’s none of their business. Even if it is an election year.
The EU is supposed to work according to a set of well-understood principles. If we want to re-regulate the banking sector, and we should, then the recent decision to cap bankers’ bonuses is an example of how the system is supposed to work (again, irrespective of the merits of the issue). There are proposals, there is a vote, there is a decision. Fine. I’ll have more of that please.
But that is not what we are seeing here.
It might be less difficult to swallow if the German government were caped crusaders seeking to bring the entire European financial system to heel. But we all know who has been undermining the drive to have a meaningful European system of banking supervision, and it isn’t Cyprus. And is Mr Schaüble really going to try to prevent German banks from touting for business in that island, as the FT recently reported? I don’t think so. None of this means that Merkel and Schaüble are any worse than anyone else’s politicians, but if you are the arbiter of other countries’ fates, and you aren’t any better either, then there’s going to be a backlash. Which is terrible news for Germany in the long run.
My quote of the week is from another must-read article, this time by Wolfgang Münchau, who says that
I have believed for some time that it is impossible for Germany, Finland and the Netherlands to be in a monetary union with Cyprus, Greece and Portugal. Either the two sides agree to adjust more symmetrically, politically and economically, or this experiment should end.
The argument about economically asymmetric adjustment has at this stage been done to death, and almost everyone understands it, although the German government remains resolutely, proudly, and vocally, macroeconomically illiterate. Another reason why anti-German posters at mass demonstrations are something that we will have to get used to, which is tragic. But Wolfgang’s point about politically asymmetric adjustment is just as important, and gets to the heart of the matter.
When the EU club works according to its rules, people accept the outcomes, but in crises policies are made on the hoof, and it is the powerful who call the shots. This is inevitable, but it is also very dangerous, especially since the decisions that are made at times like this have a much bigger impact on peoples’ lives than anything that typically comes out of Brussels. We have been in crisis mode for much too long now, the crisis shows no signs of going away any time soon, and the political asymmetry is becoming intolerable.
A meaningful banking union, that had the power to stick its nose into the German banking system, and had a set of ex ante mutually agreed principles regarding how to resolve banks in all member states, would help reduce political asymmetries. More expansionary monetary and fiscal policies would help make economic adjustment more symmetric. I suspect we’re going to get neither, in which case we need to end the EMU experiment before it drags the broader European project down with it.
On balance I agree with Paul Krugman’s views on whether Cyprus should leave the euro or not. And most people seem to also agree with him that there will be a Cypriot public debt crisis in the not too distant future. Given what is about to happen to their GDP, how could it be otherwise?
As regards the political benefits to Cyprus of staying in the Eurozone, which Paul advances as a possible counter-argument: the Telegraph links to a piece from the Netherlands suggesting that the EU is contemplating earmarking those future Cypriot gas revenues the island has been looking forward to, to ensure that the Troika gets its money back.
Completely logical, and utterly destructive.
Colm McCarthy has a terrific piece in today’s Sunday Independent.
To his comments about money laundering hardly being something confined to Cyprus, I would add the following link.
It seems that we still don’t know how this crisis is going to end. But here is one big dilemma that I see. Implicit in Colm’s article is a recognition that a meaningful banking union is a pre-requisite for a sustainable EMU. That means common supervision, a centrally-funded deposit insurance system, and a common, tax-payer-friendly, and (where necessary) jointly funded resolution system. The core reference on banking union remains this piece by Pisani-Ferry, Sapir and Véron. This past week’s events have clearly reinforced the case for such a banking union, which necessarily involves some element of fiscal union. Without it, EMU is a dangerous place to be.
And here is the dilemma (aside from the fact that it is being made increasingly clear that the Germans are never going to be convinced that such a system would be one involving mutual insurance, rather than one-way transfers, and that the idea of a meaningful banking union may therefore be dead in the water in any event). Do the rest of us want to get even more deeply involved with a Eurozone whose decision makers are as incompetent as this lot? And do those of us who live in small countries really want to get more deeply involved in a club in which big, powerful countries and small, weak countries are not treated as equal members?
Update: according to the FT, German banks (among others) are going after the Russian business that has up to now been located in Cyprus.
This interview with Athanasios Orphanides will ring a few bells in Dublin. I remember in the autumn of 2010, when the ECB in a similar fashion threatened to pull the plug on the Irish banking system, thinking that this was not a credible threat, since such action would de facto mean expelling Ireland from the Eurozone. Would an unelected bunch of central bankers really be willing to do something so political?
I can understand why Irish policymakers were not willing to test this logic at the time, even though I was very angry with them for giving in to ECB pressure not to burn the Irish banking system’s creditors, and still think they shouldn’t have done so.
One thing seems certain however. The ECB cannot have it both ways. It cannot simultaneously threaten to expel a member state from the Eurozone, and also expect us to believe that it will do “whatever it takes” to save the euro.
What investors (and, to be honest, I) have forgotten is that Draghi qualified his pledge: the ECB would do whatever it takes “within its mandate”. It isn’t clear that investors will continue to believe that “it will be enough”.
This piece by Nicolas Véron is well worth a read, even though it was posted yesterday and the situation is fast-moving.
You leave the computer switched off during the holiday weekend, and look what the Eurozone does while you’re away! I guess we don’t know yet what the final outcome is going to be in Cyprus, and I fully share Sharon Bowles’ hopes that we haven’t seen the final word yet.
But if small depositors are going to take a hit, then, as a reminder of what we will have lost, here is a handy set of links to various EU documents and regulations regarding banking deposits. This citizen’s summary which reflects the media reports of the time helps explain why people have persisted in leaving their money in peripheral European banks for so long. It seems mad to tear this guarantee up on the grounds that Cyprus is sui generis, since as Tolstoy (almost) said…
Update: Tuesday morning, and we still don’t know what is going to happen; maybe the guarantee for savings of less than €100,000 will be honoured. But I fear that Karl and the many other commentators weighing in on the issue this morning are right, and that the long run reputation of the EU’s claim to guarantee such deposits will suffer a big hit as a result of this debacle, no matter what ultimately happens.
Timothy Garton Ash may be on to something. 2010 was clearly a turning point, when the Eurozone decided to engage in generalized pro-cyclical austerity — whether they did this because of the dodgy ideas that were floating around at the time, or simply because conservative politicians were more adept at using the crisis to further their long term goals (in their case, to shrink the state) than Europe’s useless left is something historians can debate in the future.
Garton Ash suggests that 2012 may also have been a turning point, or rather a turning point that never was: with Hollande and Monti newly installed, there was a clear demand for a more symmetric adjustment policy from pro-European Southern leaders, and an opportunity for Germany to respond favourably– after all, Monti was their man. That response never came. All we got was a June summit declaration on banking union on which there has subsequently been much backtracking. There was nothing on making short run macroeconomic adjustment less asymmetric. And now the German government is busily making matters even worse on the fiscal front.
I don’t see any way that the Eurozone can avoid a major political crisis. If the current policy mix continues unabated for the foreseeable future, then the real economy in the southern periphery will continue to worsen — unless of course something miraculously turns up, which is a possibility which we can however safely discount. Since this situation will ultimately prove politically unsustainable, the ‘steady as she goes’ scenario implies an eventual political crisis that could be quite nasty, at some unknowable date in the future — a year, or two years, or even — God help us — five or ten years from now.
But can we envisage a shift in the short run macroeconomic policy mix — looser monetary policy, more debt restructuring, a countervailing core fiscal stimulus channelled either through Germany or some EU body like the EIB — and moves towards an appropriate Eurozone architecture — a real banking union, which will require at least some element of fiscal union, and ideally some other elements of fiscal union as well — which is brought about in the absence of crisis? We have all seen how OMT has bred complacency and allowed German politicians to wriggle off the hooks on which they had been impaled last June. 2012 was a pretty good year to force change from that point of view as well; another way in which the year was a turning point that never was.
The problem of course is that a political crisis serious enough to force major reform may also lead to the collapse of the Eurozone: otherwise it won’t succeed in forcing major reform. Germany’s leaders can prove me wrong, by heeding Garton Ash’s advice and seizing their second chance. But I am afraid that they will not do so.
It isn’t Paul Krugman’s fault that the European Commission has been busily defending a macroeconomic policy mix that is doing tremendous damage to the European periphery: the EC only has itself to blame on this one. And so the latest outraged tweets emerging from the Brussels bubble are a little hard to take.
One of the tragedies of the interwar period is that the good guys — liberal internationalists — tended to support a macroeconomic policy mix that was destructive, as a result of their support for the gold standard. In so doing they helped undermine the case for liberal internationalism. It would be helpful if the cocooned elites in Brussels remembered that they are, de facto, the public face of the European project, and that when they defend the indefensible they are in their turn undermining that project.