Terrific article by Mark Mazower here.
Archive for the ‘EMU’ Category
Mario Monti has done Europe’s voters a huge service. It would have been easy for him to remain aloof during this election; by standing for election he allowed Italians to directly express their opinion on the EU’s current macroeconomic policy mix. The results are pretty conclusive: current policies have no democratic legitimacy, at least in Italy.
We all remember Jean-Claude Juncker’s statement that “We all know what to do, but we don’t know how to get re-elected once we have done it”. He got it half right: they certainly don’t know how to get re-elected. But it is also clear that they really don’t know what to do about the economy either. And this represents a huge problem for the European project, since by pinning their colours so firmly to the mast of an incoherent and destructive macroeconomic policy mix, Europe’s leaders risk doing huge damage to that project. Indeed, the damage is already occurring.
It would be nice to think that these leaders would take seriously pleas by people like Karl for a saner approach to macroeconomic policy. The evidence since September, however, is that they will sit on their hands unless forced to do otherwise by the markets: the risk of financial crisis, not the reality of peripheral unemployment crises, is what grabs their attention. Another reason to welcome the Italian vote, perhaps.
Update: Paul Krugman has a very similar reaction here.
You might have thought that the disastrous but wholly unsurprising eurozone GDP numbers indicate that the bloc is in a bad way, and will continue to be so until the current macroeconomic policy mix is jettisoned.
The current situation can be summarised like this: we have disappointing hard data from the end of last year, some more encouraging soft data in the recent past and growing investor confidence in the future.
Thank goodness for that.
By Philip LaneMonday, February 11th, 2013
(If Ashok is right then, contra Manasse, the Eurozone crisis will become a bit more symmetric, but he is right to query whether this will be good news for the project.)
And here is an account of a Slovenian constitutional court decision. If the account of the legal reasoning is accurate then this is quite appalling.
The FT has a sobering report here.
Just like a year ago, we are hearing a lot of guff about how the euro crisis is over, and just like a year ago the people I talk to in Brussels are becoming increasingly alarmed by the complacency of the European establishment. It does seem as though the only thing that makes Europe’s useless political class worry is the risk of imminent cardiac arrest, as proxied by bond yields and the like; but the cancer of unemployment will do just as much damage if allowed to progress unchecked.
Here are the latest Eurozone unemployment statistics. Just because we are becoming used to this sort of news does not mean that they are even remotely acceptable. They are grim.
There are certain costs that are obviously not worth paying to keep the EMU experiment going. One is a dilution of the continent’s democratic traditions. Another is unemployment rates of the sort we are seeing in Spain and Greece. No doubt crocodile tears will be shed by supporters of status quo macroeconomic policies, but such responses are no longer acceptable. EMU supporters, and €-sceptics who are worried about the costs of an EMU break-up, now have to start being very concrete in terms of proposing Eurozone economic policies, including short run monetary and fiscal policies, that can start reversing these trends in 2013. (A group of us tried to do so here, for example.) And then we need to see such policies being implemented, quickly.
You have to live through times like this to really appreciate the wisdom of Keynes’ famous line about the long run.
The markets are going into a minor tizzy this morning thanks to the news that Mario Monti is stepping down earlier than expected. And I can certainly understand why people like Beppe Grillo and Silvio Berlusconi might seem like a cause for alarm.
But what if Wolfgang Münchau is right, and the real problem in Italy right now is the austerity policies that Monti is pursuing, and that are being praised to the skies by the entire European establishment as we speak? Bang on cue, we learned this morning that Italian industrial output fell by 1.1% in October, much faster than expected. If Wolfgang is right, then what Europhiles (and the markets) should be devoutly hoping for is centrist, Europhile politicians willing to reject the status quo policies that are doing such damage. Why should Eurosceptics have all the best tunes?
One of the things that makes it possible for Europe’s politicians to persist with this nonsense is their conviction, like Mr Micawber, that something will turn up. There is no sign in Ireland that anything at all is turning up. The most important indicator of all, employment, is still falling, and you can see signs of strain all around if you care to look. At the panto last night, I was struck by the lack of sparkly fairy wands, light sabres, and all the rest compared with previous years: it really was very noticeable. And these were the people who could still afford to take their kids to the panto. Also noticeable was the almost complete absence of recession jokes, which were such a feature in 2008 and 2009. It just isn’t funny any more.
Colm McCarthy was in good form yesterday regarding this over-optimism in the Irish context. Of course, it is always possible that predictions of rapid growth just around the corner aren’t fuelled by optimism at all. It is at least theoretically possible that these growth predictions are whatever is required to make Ireland — the Eurozone’s supposed success story — seem solvent.
Mind you, you’d have to be a complete cynic to believe that such a thing was possible.
Update: Good Heavens Above. The corner appears to be receding from view in the Netherlands.
It would be a good thing if the leaders meeting in Brussels today were to take reports like this one seriously.
In an earlier post I drew attention to the extent to which Ireland’s recent apparent competitive gains reflected the weakness of the euro relative to the dollar and sterling.
Another component of competitiveness is, of course, our rate of inflation relative to that of the Euro area as a whole.
It is therefore of interest to put on record the inflation rates in Ireland and in the Euro area since 1999.
This is facilitated by the European Central Bank’s website, from which monthly data on the rate of inflation as measured by the Harmonised Index of Consumer Prices (HICP) may be readily downloaded.
The following Chart tells the story.
It may be seen that for the first five years of the new monetary union Ireland’s inflation rate was - contrary to expectations - significantly higher than the Euro area average. This resulted in a significant loss of competitiveness relative to the rest of the Euro area.
For the years between 2004 and 2007 our inflation rate behaved as expected in a monetary union and differed little from that of the Euro area average.
During 2009 and 2010 we experienced more deflation than the rest of the Euro area. This helped restore some of the competitiveness we had lost in the early years of membership and the ‘internal devaluation’ was hailed at the time in the belief that it would play a big role in getting the economy moving again.
Since 2010, however, our inflation rate has been climbing back up towards the Euro area average.
It would seem that any further ‘restoration of competitiveness’ will require further weakness of the euro on the foreign exchange markets.
Simon Wren-Lewis has a nice post here. The whole situation makes you wonder whether, despite all the ECB’s talk of independence, there is a major Western central bank more subject to political constraints anywhere in the world.
I would add a couple of points.
First, the ECB and the rest of us are fixated on what will fly politically in Germany; but there are 16 other member states in the Eurozone, and not all of them are as pliable as little, eager-to-please Ireland. In particular, I have always thought that there were two reasons to avoid having Italy enter a bailout programme: not just the fact that EFSF/ESM won’t have enough money, but the fact that if this happens, Italy may decide to leave EMU. The reason why economists like Paul de Grauwe have been asking for ECB intervention is so that an Italian bailout becomes unnecessary; now it seems that Italy will only get ECB intervention if it enters a bailout programme. The whole thing seems upside down, and people are playing with fire here. Despite its large debts, Italy wouldn’t be having these difficulties on the market if it wasn’t in EMU: to ask a big, important country with a sense of its own dignity to give up sovereignty — and potentially enter the same death spiral as Greece, and now apparently Spain — simply so that it can remain in a single currency that isn’t working seems like a bit of a stretch to me.
Second, I agree with Simon that the ECB’s worrying about the moral hazard facing states like Italy in a situation like this is pretty stupid. (I would add that it is also wrong because it mixes up fiscal and monetary policy. Let the ECB stick to monetary policy, and let governments, individually and collectively, stick to fiscal policy.) But in our dysfunctional, destructive monetary union it may indeed be politically necessary for the ECB to insist on fiscal policy conditionality before doing the job of a central bank. Forcing Italy into a bailout programme seems like a particularly dangerous way of doing this, however.
There is a better way I think. The IMF is signaling that Spain and Italy are doing all that could be reasonably asked of them right now. Surely if the IMF is willing to certify that a country is running a sensible fiscal policy, this should be enough to allow the ECB to do what needs to be done?
UPDATE: Francesco Giavazzi is quoted here as making an obvious and very important point: for an unelected technocrat like Monti to steer Italy into a bailout programme, with the consequent loss of sovereignty that would be involved, prior to elections, would be unacceptable.
By Philip LaneWednesday, August 1st, 2012
Landon Thomas outlines some of the reform ideas doing the rounds in policy circles and profiles some of the key participants in this NYT article. He includes the ESBies idea proposed by our euro-nomics group and a member of our group Markus Brunnermeier, as well as Daniel Gros and Graham Bishop.
I am not entirely sure if it belongs in a post with this title heading but Hans-Werner Sinn makes his own proposal in this FT op-ed.
I spent a few hours today revising and updating this paper, and was both astonished, and not surprised at all, to see the extent to which trust in the EU and its institutions collapsed in 2011. The figures below show the percentage of respondents in Eurobarometer surveys saying they trusted the institution in question, minus the percentage who said they didn’t trust it. The decline in 2011 is really quite dramatic. I am sure that the usual suspects will tell us that what Europe obviously needs is a better communications strategy. Personally, I think that less destructive economic policies would have a bigger impact.
Since Brendan and Philip have both posted on competitiveness in the past couple of days, I thought I’d follow up with a link to the following piece by Gaulier, Taglioni and Vicard.
Eurointelligence points us to a piece by Alan Beattie on the political difficulties which the IMF faces in dealing with the Eurozone crisis. As we know in Ireland all too well, while the IMF has generally been on the side of the angels, it is the ECB and EC that have called the shots, with the result that the IMF’s reputation suffers by association with Troika policies that are a complete and utter disaster. The dilemma for the IMF is that a complete withdrawal from the Eurozone crisis, while the single currency collapses, won’t do its reputation much good either.
Charles Goodhart and Sony Kapoor have it right, I think: it is the Eurozone that is dysfunctional, and in the future IMF conditionality has to be directed at the ECB and other Eurozone-level bodies as much as (if not more than) it is directed at individual member states. It’s time for the IMF to decide whether it wants to prove Peter Doyle right, or prove him wrong.
The orthodox view is that enhanced competitiveness should play a significant part in Ireland’s (and other euro area countries’) recovery from recession.
In the March 2012 “Review Under the Extended Arrangement” the IMF team states that:
“Ireland’s economy has shown a capacity for export-led growth, aided by significant progress in unwinding past competitiveness losses.” (my italics)
The evidence does indeed point to a significant improvement in Ireland’s competitiveness between 2008 and the present. The following two graphs show the ECB’s ‘Harmonized Competitiveness Indicator’ (HCI) based on (a) Consumer Prices and (b) Unit Labour Costs. (A rising index implies a loss of competitiveness.) Both graphs show a competitive gain since 2008, with second showing the more dramatic improvement. However, this measure is affected by the changing composition of the labour force, which became smaller but more high-tech as a result of the collapse of many low-productivity sectors during the recession.
Concentrating on the HCI based on the CPI, the Irish competitive gain has still been impressive – our HCI fell 17% between mid-2008 and mid-2012, giving us the largest competitive gain recorded in any of the 17 euro-area countries over these years. Greece, at the other extreme, recorded no change in its HCI, Portugal fell only 4.5%, Spain 6.6%, Italy 6.8%. So by this measure Ireland is some PIIG(S)!
However, we need to dig deeper and understand why Ireland’s HCI has fallen so steeply.
Part of the story - the part on which some commentators dwell - is that early in the recession the Irish price level and Irish nominal wages fell. From a peak of 108 in 2008 the Irish Consumer Price Index fell to 100 in January 2010. But it has started to rise again – by mid-2012 it was back up to 105. The fall in the Harmonized Index of Consumer Prices has been even less impressive – from a peak of 110 to a low of 105 and now rising back to its previous peak.
Wages are more important than prices as an index of competitiveness because price indices are influenced by indirect taxes and include many non-traded services and administered prices. But Irish nominal wages tell much the same story as the price indices. The index of hourly earnings in manufacturing peaked around 106 at the end of 2009 (2008 = 100) and then fell to a low of 102 in 2011, where it appears to have stabilized. Even in the construction sector, where employment collapsed in the wake of the building bust, wage rates declined only 6 per cent between 2008 and 2011.
Falling wages and prices are in line with what many commentators thought would happen after the surge in unemployment in 2008. Widely-publicized wage cuts in the private and public sectors were seen as part of the ‘internal devaluation’ needed to rescue the Irish economy from the recession. It was argued that this was the only way we could engineer a reduction in our real exchange rate given our commitment to the euro. (Paul Krugman likes to refer pejoratively to an ‘internal devaluation’ as simply ‘wage cuts’.)
However, the Irish wage and price deflation has not been very dramatic and seems to have stalled in 2011, even though the unemployment rate continues to climb.
So why has Ireland’s competitiveness improved so sharply since 2008 if the ‘internal devaluation’ has been so modest? The answer, of course, lies in the behaviour of the euro on world currency markets and the fact that non-euro area trade is much more important for Ireland than for any other member of the EMU.
This can be seen by looking at the HCI for the euro area as a whole. The euro area HCI fell from 100 in mid-2008 to 84.7 in mid-2012 – almost as big a fall as was recorded for Ireland and far higher than that recorded in any other euro area country.
The paradox that the euro area HCI has fallen much further than the average (however weighted) of the constituent EMU countries is explained by the fact that for each individual country the HCI is compiled using weights that reflect the structure of that country’s total international trade, but for the euro area as a whole the weights reflect the only the area’s trade with the non-euro world.
In its notes on the series the ECB draws attention to this:
“The purpose of harmonized competitiveness indicators (HCIs) is to provide consistent and comparable measures of euro area countries’ price and cost competitiveness that are also consistent with the real effective exchange rates (EERs) of the euro. The HCIs are constructed using the same methodology and data sources that are used for the euro EERs. While the HCI of a specific country takes into account both intra and extra-euro area trade, however, the euro EERs are based on extra-euro area trade only.” (my italics)
It is understandable that Ireland should show a large competitive gain by euro area standards as the euro declined on world markets after 2008 because non-euro area trade is far more important to Ireland than to any of the other 16 members of the EMU. A fall in the dollar value of the euro does nothing to make France more competitive relative to Germany, or Greece relative to either of them, but it does a lot for Ireland relative to its two most important trading partners - the UK and the US.
As a consequence, the decline in the value of the euro on world currency markets, and especially relative to sterling and the dollar, has had a much larger effect on our competitiveness than on that of any other euro area country.
The following graph shows the USD / EUR exchange rate and Ireland’s HCI since 2008. It does not take any econometrics to convince me that the main driving force behind Ireland’s competitive gain has been the weakness of the euro. Undoubtedly a more sophisticated treatment, including the euro-sterling and other exchange rates of importance to Ireland – duly weighted – would show an even closer co-movement.
This should alert us to the point that Ireland’s much-praised recent competitive gain has been due more to the weakening of the euro on the world currency markets than to domestic wage and price discipline.
No doubt it could also be shown that a significant amount of the loss of competitiveness in the years before 2008 was due to the strength of the euro.
The fault - and the blame - lay not with us but with the far-from-optimal currency arrangement under which we labour.
Continuing gains in competitiveness would therefore seem to depend more on further euro weakness than on the process of ‘internal devaluation’. Should this have been a condition of our Agreement with the Troika?
I am part of an INET-sponsored group that has been considering whether and how a collapse of the Euro can be prevented. Details of our discussions to date are available here.
The WSJ has a really good piece by Gabriele Steinhauser and Matina Stevis on the core story of the Eurogroup meeting, which seems to have slipped past the domestic media somewhat. Yes, yes, they’ll get to Ireland’s debt in September/October. Grand. The key issue of just who pays for any losses within the ESM is not settled, nor is it likely to be any time soon. From the piece:
Germany’s finance minister said that even once the euro zone’s bailout fund has been authorized to directly recapitalize struggling banks, the lenders’ host government should retain final liability for any losses.
Wolfgang Schäuble’s statement early Tuesday indicated disagreements on how far the currency union needs to go to protect countries from expensive bank failures. His declaration, which followed more than nine hours of talks between euro-zone finance ministers here, clashed with those of other officials, who insisted that banks’ host states wouldn’t have to guarantee any support from the bailout fund.
The issue is hugely important for Spain, which risks being locked out of financial markets amid concerns over how a European bailout for its banks will affect Madrid’s ability to repay investors.
Fun times ahead.
Like many people, I suspect, I usually check in on Sunday night to see what Wolfgang Münchau has said this week. This week’s article was a cracker, and it’s hard to see where he’s wrong. Either governments decide to make the radical reforms that are needed, or monetary union collapses: the news from Brussels this morning suggests that they are not going to do the necessary any time soon. The Government and Central Bank have had a long time now to get contingency plans in place, and it would be nice to think that they had actually done so.
Well, it seems obvious to me at any rate: here. If the EFSF/ESM still doesn’t have enough money to deal with Italy and Spain, then we are still in multiple equilibrium territory: if the markets don’t panic, they will be right, and if they do panic, they will also be right.
Don’t get me wrong: this was a good summit that made some important intellectual breakthroughs. But there are only so many things that one summit can do, and we have had so many bad summits that it isn’t clear to me that the system can now deliver the many needed reforms in time.
Call for Papers
Bank Resolution Mechanisms
A joint academic-practitioner conference with the theme Bank Resolution Mechanisms wil be held in Dublin, Ireland on Thursday May 23rd, 2013, organized by the Financial Mathematics and Computation Cluster (FMCC) at University College, Dublin and the Department of Economics, Finance & Accounting at National University of Ireland Maynooth. (more…)
You can find it here. They usefully distinguish between short run and long run responses to the crisis, and correctly stress the need to maintain aggregate demand in the short run.
As for the long run reforms: if the euro survives, there will have to be “a broad-based dialogue about what a fuller fiscal union would imply for the sovereignty of member states and the accountability of the center,” and we may as well start thinking about these issues in Ireland now.
I notice that Philip’s last post has attracted very few comments, which is a shame, since the paper he linked to is a very important contribution to the debate, both here and in Europe, and deserves to be read widely. It is especially useful for people overseas seeking to draw lessons from the Irish experience, since it highlights the extent to which the Irish “good news story” is in fact a story about pharmaceuticals. Hence I hope Philip will forgive me if I make these comments “on the front page”, as it were.
Among the key findings are:
1. Wages declined only very slightly after the onset of the crisis here, and have since recovered. More generally, the European evidence is that wages are sticky downward.
2. The decline in unit labour costs in Ireland has been very modest once you take compositional effects into account (Figure 3, middle panel): they have been rising since 2010 and are now less than five percent lower than at the start of 2008. Indeed, for the economy as a whole they are back where they started (the previous statement was based on excluding agriculture, construction, real estate and the public service).
3. Despite 2, there has been a 14 percent depreciation of the Irish real exchange rate even taking compositional effects into account (once again, the index excludes agriculture, construction, real estate and the public service; including these the real depreciation is about half as big — Figure 3, right hand panel).
4. The Irish real exchange rate has been appreciating since 2010.
5. Peripheral adjustment has involved massive employment losses.
Here are some questions I have:
1. What happens when you calculate a composition-adjusted real exchange rate index for Ireland vis à vis other eurozone members only?
2. What happens if you include agriculture in the index? This is an important traded sector in the Irish context.
3. What happens if you do both 1 and 2?
4. One of the most striking graphs in the paper is Figure 2 on p. 6, which shows that while while manufacturing value added has risen by 30 percent since the start of 2008 (thanks to what happened in the pharmaceutical sector), gross production has only risen by 5 percent. Can we make further progress in understanding this discrepancy (there are some helpful suggestions in the paper), and what might this tell us about the movement in Irish unit labour costs and real exchange rates since the crisis began?
Update: Zsolt has kindly responded to my questions here.
Niamh Hardiman has a post here which echoes one of the most important points George Soros made in his Trento speech: current EU policies are amplifying anti-EU sentiment, which in turn makes it more difficult politically to move towards the tighter Eurozone integration that is economically required to save the Euro project; which in turn exacerbates the economic situation, and so on.
I have two brief comments.
The first is that this sort of negative feedback loop suggests the need for a “big bang” approach to policy reform in Europe: not some temporary liquidity fix that will give the system a little more rope to hang itself with, but a fundamental shift in the policy stance, which could change both the economic and the political dynamics.
The second is that we have got to stop referring to parties which are willing to go along with the current policy mix as “pro-European”, as if a party like Syriza is anti-European or anti-EU (it is clearly not). When Mrs Thatcher set about dismantling the social contract that had defined Britain for thirty years, this did not make her anti-British, and nor was Arthur Scargill anti-British when he tried to oppose her. People disagree, often fundamentally, about policies: that is what democracy is all about, and the moment that “Europe” is defined with any one set of policies, rather than with a framework for deciding policies collectively, it is (or ought to be) finished as a political project.
I conclude that what the EU needs right now is a loyal opposition, willing to provoke an almightily row in order to promote change. Step forward Mr Fabius?
In early 2009, the Irish domestic banks had three critical problems: insolvency, distress, and a liquidity crisis. Only one of these problems, the liquidity crisis, was solved successfully at an acceptable cost, via ECB liquidity provision. This massive liquidity provision was one key motivation for the Financial Measures Programme (FMP), which lays out a plan the banks must follow to become liquidity self-financing. Now, through no fault of the Irish banks but because of the continuing financial crisis, the liquidity target plan in the FMP is looking much too optimistic and needs some adjustment.
- 1. The loan-to-deposits target date should be changed from 2013 to (end-of) 2015.
- 2. The ECB should make clear that their liquidity assistance to Irish banks is for a longer period than originally envisioned.
Without these adjustments, the Irish domestic banks will be incentivised to continue to starve the domestic economy of credit over the next few years.
By Frank BarryMonday, June 18th, 2012
Wolfgang Munchau writes in the FT that Chancellor Merkel has rejected any proposal that might actually resolve the eurozone crisis. He notes the incentives for Spain, Greece and Italy to default and exit.
Everyone agrees on the need for big changes to bank resolution mechanisms both in Europe and in the USA. The problems with bank resolution differ in Europe and the USA, and the appropriate solutions differ too. Coco bonds make great sense for the Eurozone but are less appropriate for the USA. European regulators need to think for themselves on cocos, not just ape the muted response of US regulators. Contingent convertible (coco) bank bonds have a trigger point (such as a minimum equity/asset ratio) which when reached immediately forces a conversion of the liability from a debt to an equity claim. So when the bank gets into trouble, junior-grade debt liabilities immediately disappear and are replaced by diluted equity. Coco bank bonds are a very partial solution (at best) to the TBTF bank resolution problem in the USA. For all but the very biggest banks, the harsh and effective resolution system in the USA can close and re-open troubled banks very quickly. This type of super-fast bank resolution will never happen in the fragmented multi-national banking system of the Eurozone. Also, the technical competence of bank oversight in the USA will never be matched across all seventeen countries of the Eurozone, some of whom have long histories of weak and ineffective bank regulation. Cocos can partly substitute for weak regulatory oversight by encouraging greater market discipline emanating from bank bondholders. Cocos would fit well into the design of a politically-feasible banking union for the Eurozone.
If the euro survives, some type of contingent convertibility for bank debts in the Eurozone is likely to be part of the new banking system. Ireland as a small economy in the Eurozone would particularly benefit from a coco feature imposed on bank bonds, and should encourage this regulatory policy innovation.
The third picture in this post is really quite something.