One of the features of the credit crunch era has been the way that monetary policy has been taken to extremes. Indeed The Eagles were again ahead of events.
Take it to the limit
Take it to the limit
Take it to the limit one more time
We saw interest-rate cuts followed by the spread of Quantitative Easing and other extraordinary measures. Then we saw interest-rates especially in and around the Euro area cut to below zero and into the icy cold world of below zero or negative interest-rates. In the last few days we have got more hints in this area from the European Central Bank. At its last meeting its President Mario Draghi told us this and the emphasis is mine.
Let me say that rates will stay low, very low, for a long period of time, and well past the horizon of our purchases. From today’s perspective, and taking into account the support of our measures to growth and inflation, we don’t anticipate that it will be necessary to reduce rates further
Yet on Friday in La Repubblica Peter Praet of the ECB told us this.
In the Introductory Statement we said very clearly that we “expect the key ECB interest rates to remain at present or lower levels for an extended period of time, and well past the horizon of our net asset purchases.
That is a complete U-Turn and is an example of the ECB abandoning a stated position which has become very common on the Lower Bound for interest-rates. Governor Kuroda in Japan did so in only one day recently and of course Bank of England Governor Mark Carney stated it was at 0.5% whereas now he only has to look across La Manche to see one of -0.4%. Of course the situation is also one where Open Mouth Operations have been added to the list of monetary activism.
What about fiscal policy?
With the unemployment problem that the Euro area faces (10.3%) you might think that fiscal policy might have been applied. Even more so when you note the youth unemployment rate of 22%. Well it would appear that the ECB is moving in that direction as well. Here is Benoit Coeure in Paris today and this comes after a fair bit of triumphialism about ECB monetary policy.
But the ECB cannot single-handedly create the conditions for a sustainable recovery in growth. This requires a concerted effort in terms of economic and fiscal policies.
Such as Benoit?
It’s true that there is limited room for manoeuvre in terms of using fiscal policy to support growth, and the fiscal rules cannot be stretched to the point where they would lose all their credibility. But while some countries have such margins under the Stability and Growth Pact (which they are already partly using to support refugees), all countries can make their tax structures more favourable to growth and redirect public spending towards investment, research and education.
There is a clear guide towards Germany there which I shall return to in a moment. But let me address the “credibility” of the “Stability and Growth Pact” which is an attempt to distract from the fact that it has none because it was ignored with both France and Germany cruising through its rules. There is a possible context here as the Euro area may have set its stall against fiscal policy because it had overdosed on it. To be more specific there is Italy and Portugal which have ever growing national debts ( a ratio to GDP of around 130%) but very little economic growth to show for it.
The Monthly Bulletin joins in
Today’s monthly bulletin joins the growing chorus.
Low levels of public investment, if maintained over a prolonged period, may lead to a deterioration of public capital and diminish longer-term output.
The ECB technocrats were no doubt particularly pleased that they can slap themselves on the back along the way.
In this debate it is argued that public investment would be particularly effective in an environment of low borrowing costs for governments, in which monetary policy interest rates stand at around zero.
Well done us! Actually there has been an easing of fiscal policy here as lower borrowing costs have ceteris paribus allowed governments to spend more elsewhere. Also there is a technocratic element here as it pushes the case for investment. We see this in the UK but “investment” is something of a mythical beast which is hard to pin down. After all past UK-French investment produced Concorde which looked stunningly beautiful as it flew over Battersea set against a blue sky but was an economic failure as the Boeing 747 marched on. Actually later on the ECB admits this.
the distinction between investment and other government expenditure is not always clear
There are of course other problems for the ECB.
In particular, recent years have seen the ratio decline in countries that had to undergo sizeable fiscal adjustment owing to market pressure.
Awkward to say the least as it is the countries which have the highest unemployment rates who have been forced to undergo Euro area austerity. Even more awkward when you consider that the ECB has been a cheerleader for this, remember the letter to the government of Italy and its role in the Troika in Greece.
The fiscal positions of many EU countries remain precarious, however, and the provisions of the Stability and Growth Pact call for further fiscal consolidation in many of them.
You do not need to take my word for it as we have official confirmation in the way that the Troika switched names to institutions in the same way that the leaking Windscale nuclear reprocessing plant became the leak-free Sellafield!
Rather like the god Janus the ECB is looking both ways on this issue as it seems to want further fiscal consolidation in the countries that would most benefit from fiscal policy but also to have it.
An increase in public investment has positive demand effects and can contribute to the economy’s potential output by increasing the stock of public capital.
Having your cake and eating it!
As we so frequently find Germany is at the heart of this problem. From Destatis.
Net lending of general government amounted to roughly 19.4 billion euros in 2015 according to updated results of the Federal Statistical Office (Destatis). In absolute terms, this was the highest surplus achieved by general government since German reunification. When measured as a percentage of gross domestic product at current prices (3,025.9 billion euros), the Maastricht ratio of general government was +0.6%.
Yes you did read that right after having a budget or fiscal deficit of 4.2% of GDP in 2010 Germany quite quickly headed for a balanced budget and in the last couple of years has run a surplus.Presumably the negative bond yields it has will continue the trend in 2016. So the “engine” of the Euro area and indeed European economy has decided to apply a literal form of austerity. This poses a problem as with its trade surpluses the economy which should be running a fiscal deficit in the Euro area is Germany which has done exactly the reverse. Whilst Germany for its own ends might consider a balanced budget to be a good idea the deficit nations badly need Germany to run a deficit in the hope that it will bring them extra business. If you like a quid pro quo for Germany receiving a much lower exchange rate.
There is much to consider here as the Euro area did apply fiscal policy but in the opposite direction to what it now appears to be cheerleading for! Not only were places like Greece Portugal and Italy put under a lot of pressure but Germany decided to do so as well. The ECB found itself having to take over much of economic policy as the political establishment looked the other way. Monetary policy became the only game in town and led us to negative interest-rates and yields a plenty.
Let me now widen the issue of fiscal policy to the UK. We have gone through a few days of a omnishambles in the UK on this front where an austerity effort has collapsed quickly. If so are we at a boundary of sorts? Let me throw in this from the Institute of Fiscal Studies.
In the longer term the public finances are kept on track only by adding yet another year of planned austerity on the spending side.
Not jam but pain tomorrow. We seem to be hitting trouble at a level of just below 4% of GDP per year as a fiscal deficit. A while ago we discussed that announced GDP growth of 2% per annum may be the new zero is a fiscal deficit of 4% per annum like that?
If we widen the geographical focus we see Japan grappling with this issue. It has an annual fiscal deficit of 6% of GDP and yet when it tried to do something about it via a consumption tax rise the economic effects were of very bad indigestion. Is that stimulus due to its size or austerity as it tries to shrink it? However you spin it it means that by contrast the Euro area overall has been very austere.
One area where there is clear inflation is in policy U-Turns which no doubt is an influence on this below from Bloomberg.