Global Economic Watch


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  • Jeffrey Frankel on Europe's Need to Ease

    Europe needs to do something, according to Jeffrey Frankel . Specifically, the European Central Bank needs to do something about low inflation, which could soon become deflation in some EU economies. So Frankel is advocating for easing monetary policy. Does that mean quantitative easing? Not so much. Frankel: QE would present a problem for the ECB that the Fed and other central banks do not face. The eurozone has no centrally issued and traded Eurobond that the central bank could buy. (And the time to create such a bond has not yet come.) That would mean that the ECB would have to buy bonds of member countries, which in turn means taking implicit positions on the creditworthiness of their individual finances. Germans tend to feel that ECB purchases of bonds issued by Greece and other periphery countries constitute monetary financing of profligate governments and violate the laws under which the ECB was established. The German Constitutional Court believes that OMTs would exceed the ECBs mandate, though last month it temporarily handed the hot potato to the European Court of Justice. The legal obstacle is not merely an inconvenience but also represents a valid economic concern with the moral hazard that ECB bailouts present for members’ fiscal policies in the long term. That moral hazard was among the origins of the Greek crisis in the first place. Fortunately, interest rates on the debt of Greece and other periphery countries have come down a lot over the last two years. Since he took the helm at the ECB, Mario Draghi has brilliantly walked the fine line required for “doing what it takes” to keep the eurozone together. (After all, there would be little point in preserving pristine principles in the eurozone if the result were that it broke up. And fiscal austerity by itself was never going to put the periphery countries back on sustainable debt paths.) At the moment, there is no need to support periphery bonds, especially if it would flirt with unconstitutionality. What, then, should the ECB buy, if it is to expand the monetary base? It should not buy Euro securities, but rather US treasury securities. In other words, it should go back to intervening in the foreign exchange market. Here are several reasons why. First, it solves the problem of what to buy without raising legal obstacles. Operations in the foreign exchange market are well within the remit of the ECB. Second, they also do not pose moral hazard issues (unless one thinks of the long-term moral hazard that the “exorbitant privilege” of printing the world’s international currency creates for US fiscal policy). Third, ECB purchases of dollars would help push the foreign exchange value of the euro down against the dollar. Such foreign exchange operations among G-7 central banks have fallen into disuse in recent years, in part because of the theory that they don’t affect exchange rates except when they change money supplies. There is some evidence that even sterilized intervention can be effective, including for the euro. But in any case we are talking here about an ECB purchase of dollars that would change the euro money supply. The increased supply of euros would naturally lower their foreign exchange value. Read the full post here .
  • Bloomberg: 'The European Debt Crisis Visualized'

    The European debt crisis is old news. And while the heat may have come down in the last year, it is not over. The interactive team at Bloomberg News has put together a new way of telling the story of the debt crisis. Some students may find the debt crisis easier to understand through this visualization. And we appreciate that this telling of the story goes back almost a century, so there students get the deeper context of Europe's current challenges.
  • Draghi Stands By European Central Bank Reform Policies

    European Central Bank head Mario Draghi deserves some credit for starting the year off with courage. He sat down for a candid interview with German newspaper Der Spiegel, and answered some tough questions. Darghi defended the ECB's approach to crises in Greece and other struggling EU nations. And he took on criticism coming from German politicians and pundits. Here is an excerpt: SPIEGEL: We have a feeling that the number of governments which can no longer hear your tune is growing. The new coalition government in Germany, for example, wants to undo the pension reforms made by the former coalition government comprised of the center-left Social Democrats and the Green Party years ago and introduce a universal minimum wage of €8.50 ($11.67). Are these policies that help the euro? Draghi: It is too early to assess the policies of the new German government. I can only say that the crisis has shown that the monetary union is incomplete and that the weaknesses need to be remedied. Germany helps the euro best by further strengthening its competitiveness and promoting growth. Whatever helps that process is right, everything else is wrong. SPIEGEL: Many economists represent a completely different theory. They regard Germany's competitiveness as the real problem of the euro area and are calling for state curbs on exports. What do you think of that? Draghi: Not much. It's a mechanistic perspective of economic activity, and there's little I can do with it. We won't make the weak stronger by making the strong weaker, as a very wise man once said. That applies to the economy as well. If Germany were less competitive, the euro area as a whole would lose, because less could be produced then. SPIEGEL: In Germany, ECB policy is unpopular because you have now pushed the interest rates for investments down so far that they are often no longer enough to compensate for inflation. In other words, only fools save. Draghi: That's not the fault of the ECB The link between the short-term interest rates set by the ECB and the long-term interest rates paid on investments which are relevant for savers in Germany is not very strong. SPIEGEL: Really? It's a stated goal of your policy to indirectly suppress long-term interest rates. Draghi: No, especially in recent years, we were unable to control long-term interest rates -- because investors were very unsettled by the euro crisis. That's why everyone has been taking money into Germany to buy safe German government bonds. That's why the interest rates in Germany have fallen. We take the concerns of savers very seriously. But how can we respond? We run monetary policy for the entire euro area, not for a single country. If we are able to dispel the uncertainty, many investors will again take their money out of Germany and back to their home countries and interest rates will rise again. Read the full interview here . Hat tip Antonio Fatas .
  • IMF: 'More Fiscal Integration to Boost Euro Area Resilience'

    In a new paper out this week, IMF researchers call for "deeper fiscal integration" among euro area countries. In reading the paper, it appears IMF researchers view the euro experiment as incomplete. Despite struggles during the global economic crisis and global recession, there is confidence in the euro area, but no so much in its current "architecture." From the paper: Large country-specific shocks. While it was recognized that countries joining the euro area had significant structural differences, the launch of the common currency was expected to create the conditions for further real convergence among member countries. The benefits of the single market were to be reinforced by growing trade, and financial, links—making economies more similar and subject to more common shocks over time (Frankel and Rose, 1998). In that context, these common shocks would be best addressed through a common monetary policy. Instead, country-specific shocks have remained frequent and substantial (Pisani-Ferry, 2012; and Figure 1). Some countries experienced a specific shock through a dramatic decline in their borrowing costs at the launch of the euro, which created the conditions for localized credit booms and busts. The impact of globalization was also felt differently across the euro area, reflecting diverse trade specialization patterns and competitiveness levels (Carvalho, forthcoming). These country-specific shocks have had lasting effects on activity. And divergences in growth rates across countries have remained as sizeable after the creation of the euro as before (Figure 2). Deeper into the paper we start to see some proposed solutions: Long-term options for the euro area. Cooperative approaches to foster fiscal discipline have shown their limits in the first decade of EMU. On that basis, and in light of international experience, two options emerge to foster fiscal discipline in the euro area in the longer term. One could be to aim to restore the credibility of the no bailout clause, including through clear rules for the involvement of private creditors when support facilities are activated. But the transition to such a regime would have to be carefully managed and implemented in a gradual and coordinated fashion, so as to not trigger sharp readjustments in investors’ portfolios and abrupt moves in bond prices. Another option would be to rely extensively on a center-based approach and less on market price signals. This would, however, have to come at the expense of a permanent loss of fiscal sovereignty for euro area members. In practice, the steady state regime might have to embed elements of both options, with market discipline complementing stronger governance. Read a summary of the paper, and download the full paper, here .
  • Markit Economics: Euro Zone Business Activity Picks Up

    Business is picking up across the Euro Zone, according to the latest Purchasing Managers Index release from Markit Economics . An upturn in new business activity, combined with increased activity in both the service and manufacturing sector, drove PMI to its highest level in 27 months. In fact, the survey shows increases pretty much across the board, with one notable exception. Employment continues to lag. Here's a look a the trend: Comments from Chris Williamson , Chief Economist at Markit, in the release: “An upturn in the Eurozone PMI in September rounds off the best quarter for over two years, and adds to growing signs that the region is recovering from the longest recession in its history. “It is particularly encouraging to see the business situation improved across the region. Although the upturn continued to be led by Germany, France saw the first increase in business since early-2012 and elsewhere growth was the strongest since early-2011. “Employment continued to fall, though it is reassuring that the rate of job losses eased to only a very modest pace, suggesting that employment could start rising again soon. “The overall rate of growth signalled by the Eurozone PMI remains modest, however, consistent with gross domestic product rising by a meagre 0.2% in the third quarter. While rising inflows of new business bode well for a further upturn in the fourth quarter, policymakers at the ECB will no doubt view it as too early to change their stance on keeping policy on hold for an extended period.” Read the full release here .
  • IMF Calls for 'Concerted Action' Among Eurozone Leaders

    The IMF released its latest assessment of the Euro Area economy this week. While IMF Managing Director Christine Lagarde commended EU leaders for taking strong action to stem the financial crisis, there is clearly a lot of work to be done before the Eurozone restarts growth. Here is an abbreviated version of the IMF assessment, taken from the headlines within the report: 1. Important actions at both the national and euro-wide levels have tackled the immediate threats to the single currency evident at this time last year. 2. Nevertheless, the centrifugal forces across the euro area remain serious and are pulling down growth everywhere. 3. In this setting, reviving growth and employment is imperative. 4. Stronger bank balance sheets are essential for economic recovery. 5. A credible assessment of bank balance sheets is necessary to lift confidence in the euro area financial system. 6. Full banking union is necessary to reduce financial fragmentation. 7. This calls for expediting the reforms in train. 8. A strong single resolution mechanism is critical to ensure timely and least-cost resolution of banks. 9. More support from the ECB could also help reduce fragmentation. 10. Given weak growth and subdued inflation, more monetary easing will likely be necessary to support demand. 12. The unfinished agenda here is large—but also promising. 13. The challenge to boost growth and create jobs calls for concerted policy action at the pan-European and national levels. IMF analysts proposed four key tasks for EU policymakers. You can read and them, and read beyond the headlines listed above, here .
  • Global Ethics Corner: 'When Banks Fail, Who Should Pay?'

    Here's a useful conversation starter from the Carnegie Council 's Global Ethics Corner . It sets up the key questions over the IMF, EU, and European Central Bank bailout of Cyprus. While Cyprus as a nation is rather singular, the issues raised by the terms of the bailout are relevant across Europe moving forward:
  • Can Investors Spot the Next Cyprus?

    While we continue to watch events in Cyprus , MarketWatch 's Jim Je l ter looks at countries that might be "the next Cyprus." To be more specific, Jeiter notes other countries where the overall economy is highly dependent on the banking sector. Switzerland and the UK, for example, are two countries that are, as Jelter puts it, "most exposed to the ups and downs of their banks":
  • Watching Cyprus

    In Europe, all eyes are out to sea...looking at the island nation of Cyprus. On Saturday, Cypriot leaders agreed to a plan with EU authorities that includes a "one time tax" on bank deposits. This has set off protests in Cyprus and a lot of discussion, whether we will see a run on the banks there, and what the long term effects on the European and global economies will be. The Guardian has a running, minute-by-minute blog following events in Cyprus, here . But for those just getting up to speed on the news, we recommend a short piece from Antonio Fatas When it comes to the government of Cyprus, they are hopeful that everyone will understand that this was a one-time event and that the country can now move forward. From CNBC here is a quote from the Cyprus finance minister Michael Sarris: "Absolutely, there is no capital restrictions, people can move. We hope people will believe us, believe the collective leadership of the European Union, that this was a necessary step, but a single shot at the problem, and that from now on they can be very confident that nothing will happen to their savings." This will not happen, people will not believe them (not to mention the fact that the parliament has postponed the approval of the agreement that was scheduled to happen on Sunday). Prepared for several rounds of panic. I doubt the banking system will be able to operate without some capital restrictions over the coming days. On the other side, there are those who panic that this is the prelude of bank runs in Greece, Spain, Portugal or Italy. This is certainly a possibility and we have already seen withdrawals of deposits in some of these countries during this crisis, but it will take a lot of panic to produce a significant bank run. The reason is that there are still costs or barriers to produce a widespread bank run in these countries. The assumption that all the depositors in these banks will immediately open an account in Germany and transfer all their funds is (fortunately) not obvious. There are significant restrictions in opening of bank accounts even within the Euro area if depositors do not have residence in the country where the bank is established. Of course, there is always the option of hiding all your deposits under your mattress (or a cash vault) but both they represent a risk or they simply are not practical enough. Having said that, in the event where there is a strong perception that a similar "one-time-tax" is about to happen in other countries, these barriers will not be enough, so a bank run cannot be ruled out either. Read the full piece here .
  • WSJ: Why Most Euro Area Citizens Don't Want to Break Up With the Euro

    While the euro has been much maligned in the media, most citizens in euro area nations are reluctant to turn back from the currency. The Wall Street Journal 's Alessandra Galloni reports that many Europeans see the shared currency as a hedge against some corruption, and as important for civic, if not purely economic reasons:
  • German Exports Set to Hit Record High

    There seemed to be no bright lights for European economies in 2012. But perhaps we were not looking closely enough at what was happening in some of the EU's stronger economies, like Germany. While we were watching Angela Merkel and German citizens struggle with how debt crises in Greece and Spain and Italy would affect everyone in the Euro Zone, German exports, apparently, were doing quite well. From Der Spiegel : In the first 11 months of 2012, exports grew 4.3 percent to €1.018 trillion ($1.335 trillion), the Federal Statistics Office said. Stagnant sales to the rest of the European Union contrasted with a 10.4 percent jump in exports to non-EU nations. Separately, the Federation of German Wholesale, Foreign Trade and Services (BGA) said it expects the value of exports to have reached €1.103 trillion in 2012 as a whole, a four percent rise over 2011, when they exceeded the €1 trillion level for the first time. It also forecast slightly stronger export growth of 5 percent in 2013, to €1.16 trillion. Still, exports weakened at the end of 2012, pulled down by slumping demand in Europe, Germany's biggest market. Some key questions emerge from this report: 1) What does this tell us for the overall global impact of a declining Europe? 2) What role does the weakened value of the euro play in increasing sales of German exports in the U.S., Brazil, China? 3) What might the impact of continuing growth of German exports be on other European economies? Read the full article here .
  • WSJ: How the Euro Survived

    There are still a few days of 2012 left, but it seems safe to say that reports of the euro's death, to paraphrase Mark Twain, "have been greatly exaggerated." The currency remains in tact, and all members of the Euro Zone are currently sticking with it. Wall Street Journal Brussels bureau chief Stephen Fidler gives credit to ECB president Mario Draghi for staying true to his word and keeping the euro going.
  • Why European Policymakers are Paying Close Attention to the 'Fiscal Cliff' in the U.S.

    The OECD's relatively positive economic outlook , released earlier this week, presented Europe's struggles as much more worrying for the potential of the global economy than the fiscal cliff threat in the U.S. But as Dow Jones 's Nick Hastings reports, the two are not totally unrelated. Should policymakers in the U.S. not come to some agreement, then Europe is likely to feel a lot of economic pain:
  • Potholes on the Road Toward Greater European Integration

    Leading German economist Hans-Werner Sinn counts himself among those post-war Europeans who saw a more unified Europe--"the idea of a United States of Europe"--as an ideal step toward lasting stability. But, writing at Project Syndicate , Sinn shares concern that some centralized European institutions, like the European Central Bank, are taking steps that build greater rifts, rather than unity, among member states. Perhaps the idea of a United States of Europe, the dream of post-war children like me, can never be realized. But I am not so sure. After all, deeper European integration and the creation of a single political system offer solid, practical advantages that do not require a common identity or language. These advantages include the right to move freely across borders, the free movement of goods and services, legal certainty for cross-border economic activities, Europe-wide transportation infrastructure, and, not least, common security arrangements. Banking regulation is the most topical area in which collective action makes sense. If banks are regulated at the national level, but do business internationally, national regulatory authorities have a permanent incentive to set lax standards to avoid driving business to other countries and to lure it from them instead. Regulatory competition thus degenerates into a race to the bottom, since the benefits of lax regulation translate into profits at home, while the losses lie with bank creditors around the world. There are many similar examples from the fields of standards, competition policy, and taxation that are applicable here. So, fundamental considerations speak for deeper European integration, extending even to the creation of a single European state. Comments making bodies not only provide services that are useful to everybody, but also may abuse their power to redistribute resources among the participating countries. Even democratic bodies are not immune to this danger. On the contrary, they make it possible for majorities to exploit minorities. To counter this threat, democratic bodies invariably need special rules to protect minorities, such as the requirement of qualified majority voting or unanimous decision-making. Read Europe's Path to Disunity here .
  • 'Chronic Uncertainty' Slowing Business in Europe

    Humans do not handle uncertainty well. So Europe's struggles has a lot of us nervous, in large part because we are having a difficult time figuring out potential scenarios for positive resolution. Europe's businesses have been affected greatly by the uncertainty, according to John Thanassoulis , a lecturer in the Oxford University Economics Department. Thanassoulis has been looking at the impact of the Euro Crisis on businesses in Europe, and he finds they are suffering from a sort of economic inertia and are highly reluctant to take any risks. Thanassoulis shared his findings with The Economist 's Peter Collins :