An expansion of fiscal policy in the Euro area might help to keep Italy in it

After the action or in many ways inaction at the Bank of England last week there was a shift of attention to the ECB or European Central Bank. Or if you prefer from Governor Mark Carney to President Mario Draghi. This is because tucked away in a rather familiar tale from him in a speech in Florence was what you might call parking your tanks on somebody else’s lawn. It started with this.

One is the ECB’s OMTs, which can be used when there is a threat to euro area price stability and comes with an ESM programme. The other is the ESM itself.

Actually rather contrary to what Mario implies Outright Monetary Transactions or OMTs were never required as the ECB instead expanded its bond puchases via the Quantitative Easing programme which is ongoing currently at a flow of 30 billion Euros a month. One might also argue the European Stability Mechanism has caused anything but in Greece however the fundamental point is that via such mechanisms monetary policy has slipped under and over and around the border into fiscal policy. For example after the progress in the coalition talks in Italy the financial media has moved onto articles about the Italian national debt being un affordable when in fact the factor that has made it affordable is/are the 342 billion Euros of it that the ECB has purchased. The Italy of 7% bond yields at the time of the Euro area crisis would not have reached now in the same form whereas the current Italy of around 2% yields has.

But there is more than tip-toeing onto the fiscal lawn below.

So, we need an additional fiscal instrument to maintain convergence during large shocks, without having to over-burden monetary policy. Its aim would be to provide an extra layer of stabilisation, thereby reinforcing confidence in national policies.

As no doubt you have already recognised that particular lawn has been mined with economic IEDs as Mario then implicitly acknowledges.

And, as we have seen from our longstanding discussions, it is certainly not politically simple, regardless of the shape that such an instrument could take: from the provision of supranational public goods – like security, defence or migration – to a fully-fledged fiscal capacity.

The only one of those that is pretty non contentious these days is the security issue and that of course is because of the grim nature of events in that area. However the movement of ECB tanks onto the fiscal lawn continued.

But the argument whereby risk-sharing may help to greatly reduce risk, or whereby solidarity, in some specific circumstances, contributes to efficient risk-reduction, is compelling in this case as well, and our work on the design and proper timeframe for such an instrument should continue.

All of that is true and just in case people missed it then the ECB broadcasted it from its social media feeds as well.

Why has Mario done this?

One view might be that as he approaches the end of his term he feels that he can do this in a way he could not before. Another ties in with a theme of this website which is to use the words of Governor Carney that monetary policy may not be “maxxed out” but there are clear signs of fatigue and side-effects. Mario may well have had a sleepless night or two as he thinks of his own recent words about the Euro area economy.

When we look at the indicators that showed significant, sharp declines, we see that, first of all, the fact that all countries reported means that this loss of momentum is pretty broad across countries. It’s also broad across sectors because when we look at the indicators, it’s both hard and soft survey-based indicators.

Where this fits in with my theme is that this is happening with an official deposit rate of -0.4% and not only an enormously expanded balance sheet but ongoing QE. Thus the sleepless nights will be when Mario wonders what  to do if this also turns out to be ongoing? The two obvious monetary responses have problems as whilst what economists call the “lower bound” has proved to be yet another mirage that is so far and plunging further into the icy cold world of negative interest-rates increases the risk of a dash to cash. The second response which ties in with the issue of policy in Germany is that the ECB is running out of German bunds to buy so firing up the QE operation again is also problematic.

Fiscal Policy

The problem puts Mario on an Odyssey.

And if you’re looking for a way out
I won’t stand here in your way.

In terms of economic theory there is a glittering prize in view here but sadly it only shows an example of what might be called simple minds. This is because at the “lower bound” for interest-rates in a liquidity trap  fiscal policy will be at its most effective according to that theory. So far go good until we note that the “lower bound” has got er lower and lower. There was of course the Governor Carney faux pas of saying it was at 0.5% and then not only cutting to 0.25% but planning to cut to 0.1% before the latter was abandoned but also some argued it was at 0% and of course quite a bit of the world is currently below that.

So Mario is calling for some fiscal policy and as so often all eyes turn to Germany which as I have pointed out before is operating fiscal policy but one heading in the opposite direction as I pointed out on the 20th of November.

Germany’s federal budget  surplus hit a record 18.3 billion euros ($21.6 billion) for the first half of 2017.

This poses various problems as I then pointed out.

With its role in the Euro area should a country with its trade surpluses be aiming at a fiscal surplus too or should it be more expansionary to help reduce both and thus help others?

As you can see Mario is leaving the conceptual issue behind and simply concentrating on his worries for 2018. This of course is standard Euro area policy where changes come in for an emergency and then find themselves becoming permanent. Although to be fair they are far from alone from this as I note that Income Tax in the UK was supposed to be a temporary way of helping to finance the Napoleonic wars.

Comment

This speech may well turn out to be as famous as the “Whatever it takes ( to save the Euro) one. In terms of his own operations Mario has proved to be a steadfast supporter of it but the monetary policy ammunition locker has been emptied. It is also true that it means he has been something of a one-club golfer because the Euro area political class has in essence embraced austerity and left Mario rather lonely. Now his time is running out he is in effect pointing that out and asking for help. Perhaps he is envious of what President Trump has just enacted in the United States.

There are clear problems though. We have been on this road before and it has turned out to be a road to nowhere in spite of many talking heads supporting it. In essence it relies in the backing of Germany and it has been unwilling to allow supranational Eurobonds where for example Italy and Greece could borrow with the German taxpayer potentially on the hook. If anything Germany seems to be heading in the direction of being even more fiscally conservative.

If we look wider we see that at the heart of this is something which has dogged the credit crunch era. If you believe one of the causes of it was imbalances well the German trade surplus has if anything swelled and now it is adding fiscal surpluses to that. Next if we look more narrowly there are the ongoing ch-ch-changes in Mario’s home country Italy. From the Wall Street Journal.

Both parties vowed to scrap or dilute an unpopular pension overhaul from 2011 that steadily raises the retirement age. Economists say the parties’ fiscal promises, if enacted in full, would greatly add to Italy’s budget shortfall, likely breaking EU rules that cap deficits at 3% of gross domestic product. Italy’s public debt, at 132% of GDP, is the EU’s highest after Greece.

So is it to save the Euro or to keep Italy in it?

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The economy of Italy continues to struggle

It is past time for us to revisit the economy of Italy which will no doubt be grimly mulling the warnings of a Euro area slow down from ECB ( European Central Bank) President Draghi and Italians will be hoping that their countryman was not referring to them.

When we look at the indicators that showed significant, sharp declines, we see that, first of all, the fact that all countries reported means that this loss of momentum is pretty broad across countries. It’s also broad across sectors because when we look at the indicators, it’s both hard and soft survey-based indicators.

We know that Bank of Italy Governor Visco will have given his views but at this stage we have no detail on this.

 All Governing Council members reported on the situation of their own countries.

This particularly matters for Italy because its economic record in the Euro era has been poor. One different way of describing those has been released this morning by the Italian statistical office.

In March 2018, 23.134 million persons were employed, +0.3% over February. Unemployed were 2.865 million, +0.7% over the previous month.

Employment rate was 58.3%, +0.2 percentage points over the previous month, unemployment rate was 11.0%, steady over February 2018 and inactivity rate was 34.3%, -0.3 percentage points in a month.

Youth unemployment rate (aged 15-24) was 31.7%, -0.9 percentage points over the previous month and youth unemployment ratio in the same age group was 8.3%, -0.3 percentage points over February 2018.

The long-term picture implied by an unemployment rate that is still 11% is not a good one as we note that even in the more recent better phase for Italy it has not broken below that level. Actually Italy has regularly reported that it has ( to 10.8% or 10.9%) but the number keeps being revised upwards. Now whether anyone really believed the promises of economic convergence given by the Euro founders I do not know but if we look at the unemployment rate released by Germany last week there have to be fears of divergence instead,

The adjusted unemployment rate was 3.4% in March 2018.

The database does not allow me to look back to the beginning of the Euro area but we can go back to January 2005. Since then employment in Italy has risen by 722,000 but unemployment has risen by 977,000 which speaks for itself.

If we look at the shorter-term it is hardly auspicious that unemployment rose in March although better news more in tune with GDP ( Gross Domestic Product) data in 2017 is the employment rise.

Manufacturing

The warning from ECB President Draghi contained this.

 Sharp declines were experienced by PMI, almost all sectors, in retail, sales, manufacturing, services, in construction.

We can say that this continued in the manufacturing sector according to the Markit PMI.

The recent growth slowdown of the Italian
manufacturing sector continued during April as
weaker domestic market conditions limited order
book and production gains. Business sentiment
softened to an eight-month low.

The actual number is below.

declined for a third successive month
in April to reach a level of 53.5 (from 55.1 in
March). The latest PMI reading was the lowest
recorded by the survey since January 2017.

So a fall to below the UK and one of Mario’s sharp declines which seems to be concentrated here.

The slowdown was centred on the intermediate
goods sector, which suffered a stagnation of output
and concurrent declines in both total new orders
and sales from abroad.

If we try to peer at the Italian economy on its own this is hardly reassuring.

There were widespread reports of a
softening of domestic market conditions which
weighed on total order book gains.

Also it seems a bit early for supply side constraints to bite especially if we look at Italy’s track record.

“On the contrary, anecdotal evidence in recent
months has pointed to global supply-side
constraints as a factor limiting growth, and these
issues in April were exacerbated by increased
weakness in domestic market conditions

GDP

This morning’s official release is a bit of a curate’s egg so let us go straight to it.

In the first quarter of 2018 the seasonally and calendar adjusted, chained volume measure of Gross
Domestic Product (GDP) increased by 0.3 per cent with respect to the fourth quarter of 2017 and by 1.4 per
cent in comparison with the first quarter of 2017.

So the good news is that the last actual quarterly contraction was in the spring of 2014 and since then there has been growth. But the problem is something we have seen play out many times. From February 12th 2016.

The ‘good’ news is that this is above ‘s trend growth rate of zero

It is also better than this from the same article.

The number below was one of the reasons why the former editor of the Economist magazine Bill Emmott described it as like a “girlfriend in a coma”.

between 2001 and 2013 GDP shrank by 0.2%. (The Economist)

So better than that but the recent experience in what has been called the Euroboom brings us back to my point that Italy has struggled to maintain an annual economic growth rate above 1%. The latest numbers bring that to mind as the annual rate of GDP growth has gone 1.8%, 1.6% and now 1.4%. The quarterly numbers have followed something of a Noah’s Ark pattern as two quarters of 0.5% has been followed by two of 0.4% and now two of 0.3%. Neither of those patterns holds any reassurance in fact quite the reverse.

Why might this be?

There are many arguments over the causes of the problems with productivity post credit crunch but in Italy it has been a case of Taylor Swift style “trouble,trouble,trouble” for some time now. From the Bank of Italy in January and the emphasis is mine.

Over the period 1995-2016 the performance of the Italian
economy was poor not only in historical terms but also and more importantly as compared with its
main euro-area partners. Italy’s GDP growth – equal to 0.5 per cent on an average yearly basis against
1.3 in Germany, 1.5 in France and 2.1 in Spain – was supported by population dynamics, entirely due to
immigration, and the increase in the employment rate, while labor productivity and in particular TFP
gave a zero (even slightly negative) contribution,

Comment

The main issue is that the economy of Italy has barely grown in the credit crunch era. If we use 2010 as our benchmark for prices then the 1.5 trillion Euros of 1999 was replaced by only 1.594 trillion in 2017. So it is a little higher now but the next issue is the decline in GDP per capita or person from its peak. One way of looking at it was that it was the same in 2017 as it was in 1999 another is that the 28700 Euros per person of 2007 has been replaced by 26,338 in 2017 or what is clearly an economic depression at the individual level.

It is this lack of growth that has led to the rise and rise of the national debt which is now 131.8% of annual GDP. It is not that Italy is fiscally irresponsible as its annual deficits are small it is that it has lacked economic growth as a denominator to the ratio. Thus it is now rather dependent on the QE bond purchases of the ECB to keep the issue subdued. Of course the best cure would be a burst of economic growth but that seems to be a perennial hope.

Looking ahead deomgraphics are a developing issue for Italy. From The Local in March.

Thanks to the low number of births, the ‘natural increase’ (the difference between total numbers of births and deaths) was calculated at -134,000. This was the second greatest year-on-year drop ever recorded.

On this road a good thing which is rising life expectancy also poses future problems.

As to the banking system well we have a familiar expert to guide us. So far he has had an accuracy rate of the order of -100%!

 

 

 

Where next for the Euro exchange-rate?

As we start a new week the focus will be shifting to the Euro area and its economy and exchange-rate. The reason for this comes from my article of last Wednesday which concluded with this.

The ECB finds itself in something of a dilemma. This is because it has continued with a highly stimulatory policy in a boom and now faces the issue of deciding if the current slow down is temporary or not? Even worse for presentational purposes it has suggested it will end QE in September just in time for the economic winds to reverse course.

Such thoughts were strongly reinforced in the Thursday press conference when we started with an Introductory Statement mentioning moderation.

Following several quarters of higher than expected growth, incoming information since our meeting in early March points towards some moderation, while remaining consistent with a solid and broad-based expansion of the euro area economy

At this point we merely have the ECB Governing Council covering itself either way as if they economy picks-up they will emphasis the latter bit and if it slows down they will tell us they warned about moderation. But then in his replies to questions President Draghi took things a step or two further.

 It’s quite clear that since our last meeting, broadly all countries experienced, to different extents of course, some moderation in growth or some loss of momentum. When we look at the indicators that showed significant, sharp declines, we see that, first of all, the fact that all countries reported means that this loss of momentum is pretty broad across countries. It’s also broad across sectors because when we look at the indicators, it’s both hard and soft survey-based indicators.

As I pointed out on Friday if we translate from the language of central bankers the use of “significant sharp declines” is of importance as these days they consider it their job to stop that! If you had negative interest-rates and a balance sheet of over 4.5 trillion Euros it would give you food for thought. If we look at the next bit we can see that it did as it occupied so much time they did not discuss monetary policy at all.

 First of all, the interesting thing is that we didn’t discuss monetary policy per se. All Governing Council members reported on the situation of their own countries.

So they decided that as there is nothing they can do in the short-term and policy is already expansionary there was nothing to do. Also they were again caught on the hop.

And these declines were sharp and in some cases, the extent of these declines was unexpected.

Today’s monetary data

This will have attracted the attention of Mario Draghi and the Governing Council so let us start with the headline.

The annual growth rate of the broad monetary aggregate M3 decreased to 3.7% in March 2018,
from 4.2% in February.

Now let us compare it with the press conference Introductory Statement.

Turning to the monetary analysis, broad money (M3) continues to expand at a robust pace, with an annual growth rate of 4.2% in February 2018, slightly below the narrow range observed since mid-2015.

If we look through the rhetoric we see that it was already below the range that had led to the recent stronger economic growth. If we use the rule of thumb that broad money growth can be divided between economic growth and inflation we see that one of them will be squeezed. With the price of a barrel of Brent Crude Oil remaining around US $74 per barrel it seems that there will be upwards pressure on inflation from this source which may further squeeze output.

In terms of the immediate future then it is narrow money which gives us the best guide and it too was a disappointment.

The annual growth rate of the narrower aggregate M1, which includes currency in circulation and overnight deposits, decreased to 7.5% in March, from 8.4% in February.

This series peaked at just under 10% last autumn so we can see that from it we will be expecting something of a slow down over the next 6 months or so.

Is this the impact of QE?

The impact on March may well be the consequence of the reduction in monthly QE purchases from 60 billion Euros a month to 30 billion which began in January. The monthly numbers for M1 growth have gone 51 billion, 31 billion and now 20 billion so whilst it is not that simple as the numbers are erratic I think it added to an existing trend.

This leaves the ECB mulling the irony that it chose to do less as the economy weakened. Or that the expansion needs a continuous dose of the economic pick me up and cannot thrive otherwise.

What about credit?

When you consider that the taps are supposed to be fully open it was not that special.

The annual growth rate of total credit to euro area residents decreased to 2.9% in March 2018, compared
with 3.4% in the previous month.

Whilst it may not look like it from the number above but March was better than February if you look into the detail such as this one.

In particular, the annual growth rate of adjusted loans to households increased to 3.0% in March, from 2.9% in February, and the annual growth rate of adjusted loans to non-financial corporations increased to 3.3% in March, from 3.2% in February.

But such numbers are more of a lagging indicator than a leading one so we are left with a downbeat view.

Comment

In terms of first quarter data the score is 2-1. On the downside we have seen GDP ( Gross Domestic Product) growth in Belgium dip to 0.4% and more of a fall in France to 0.3%. On the other side Spain shrugged it off and grew by 0.7%. As even the German Bundesbank is expecting a slow down there it seems set to be a weaker quarter for Euro area growth and that will not have been helped by the weakness in the UK.

This means that two of the supports for the level of the Euro are weakening. The first is the fading and perhaps end of the Euroboom as the better economic growth data supported the currency. The second is a potential consequence which is the planned reduction in QE in September where eyes will soon turn to this bit from the ECB.

are intended to run until the end of September 2018, or beyond, if necessary, and in any case until the Governing Council sees a sustained adjustment in the path of inflation consistent with its inflation aim.

Actually the inflation issue is also on the cards today after this from Italy.

In April 2018, according to preliminary estimates, the Italian consumer price index for the whole nation (NIC) increased by 0.1% on monthly basis and by 0.5% compared with April 2017.

So a long way from the just below 2% objective and Portugal at 0.3% was similar. Whilst I expect the new higher oil price to change things we could see a shake-up in the plans for QE in 2018. Whilst we know it is nor as simple as more QE or more negative interest-rates equals a weaker currency a shift like that seems likely to have an effect.

Meanwhile as ever life is complex as according to the oil trader @chigrl a higher oil price boosts the value of the Euro.

Thus the foreign currency reserve balances of these oil exporting countries, in a sense, is broadly reflected by the price of oil. ……However, data also shows that they invest part of their reserves in EUR, as they sell a large share of their production to the Eurozone.

Which leads to this.

Thus, when the price of oil falls, this means that a smaller portion of USD is transferred to EUR, thus contributing to a depreciation of the currency. Inversely, when the price of oil increases, a larger portion is transferred to EUR, contributing to the appreciation of the currency.

This gets exacerbated when some try to game this.

For this reason, many funds lock their positions in EUR/USD with those in crude oil.

 

What happens if the Euroboom fades or dies?

Amidst the excitement ( okay the financial media had little else to do…) of the US ten-year Treasury Note reaching a yield of 3% yesterday there was little reaction from Europe. What I mean by this was that there was a time when European bond yields would have been dragged up in a type of pursuit. But as we look around whilst there may have been a small nudge higher the environment is completely different. Of course Germany is ploughing its own furrow with a 0.63% ten-year yield but even Italy only has one of 1.77%. In fact in a broad sweep Portugal has travelled in completely the opposite direction to the United States as I recall it issuing a ten-year bond at over 4% last January whereas now it has a market yield of 1.68%.

Of course much of this has been driven by all the Quantitative Easing purchases of the European Central Bank or ECB. This gives us a curious style of monetary policy where the foot has been on the accelerator during a boom. Putting it another way there are now over 4.5 trillion Euros of assets on the ECB balance sheet. However in another fail for economics 101 the amount of inflation generated has not been that much.

Euro area annual inflation rate was 1.3% in March 2018, up from 1.1% in February. A year earlier, the rate was
1.5%. European Union annual inflation was 1.5% in March 2018, up from 1.4% in February ( Eurostat)

As you can see the rate is below a year ago in spite of the extra QE.  However some ECB members are still banging the drum.

‘S MERSCH SAYS CONFIDENCE ON INFLATION HAS RECENTLY RISEN – BBG ( @C_Barraud )

That is an odd way of putting something which is likely to weaken the economy via lower real wages is it not? Thus confidence goes into my financial lexicon for these times especially as to most people such confidence can be expressed like this.

Global benchmark June Brent LCOM8, -0.18% settled at $73.86 a barrel on ICE Futures Europe, down 85 cents, or 1.1%. It had touched a high of $75.47, the highest level since November 2014. ( Marketwatch)

So in essence the confidence is really expectations of a higher oil price which as well as being inflationary is a contractionary influence on the Euro area economy. Here is Eurostat on the subject.

 Indeed, more than half (54.0 %) of the EU-28’s gross inland energy consumption in 2015 came from imported sources

Sadly it avoids giving us figures on just the Euro area but let us move on adding a higher oil price to the contractionary influences on the Euro area.

Oh and there is an area where one can see some flickers of an impact on inflation of all the QE. From Eurostat.

House prices, as measured by the House Price Index, rose by 4.2% in the euro area and by 4.5% in the EU in the
fourth quarter of 2017 compared with the same quarter of the previous year……….Compared with the third quarter of 2017, house prices rose by 0.9% in the euro area and by 0.7% in the EU in the fourth quarter of 2017

Those who recall the past might be more than a little troubled by the 11.8% recorded in Ireland and the 7.2% recorded in Spain.

Money Supply

I looked at this issue on the 9th of this month.

If we look at the Euro area in general then there are signs of a reduced rate of growth.

The annual growth rate of the narrower aggregate M1, which includes currency in circulation
and overnight deposits, decreased to 8.4% in February, from 8.8% in January.

The accompanying chart shows that this series peaked at just under 10% per annum last autumn.

The broader measure had slowed too which is awkward if you expect higher inflation for example from the oil price rise. This is because the rule of thumb is that you split the broad money growth between output and inflation. So if broad money growth is lower and inflation higher there is pressure for output to be squeezed.

Other signals

The Bundesbank of Germany told us this yesterday.

The Bundesbank expects the German economy’s boom to continue, although the Bank’s economists predict that the growth rate of gross domestic product might be distinctly lower in the first quarter of 2018 than in the preceding quarters.

The industrial production weakness that we looked at back on the 9th of this month is a factor as well as a novel one in a world where the poor old weather usually takes a beating.

the particularly severe flu outbreak this year ……. The unusually severe flu season is also likely to have dampened economic activity in other sectors, the economists note.

Perhaps we will see headlines stating the German economy has the flu next month. Oh and in the end the weather always gets it.

In February, output in the construction sector declined by a seasonally adjusted 2¼% on the month. This, the Bank’s economists believe, was attributable to the colder than average weather conditions.

So the boom is continuing even though it is not. As this is around 28% of the Euro area economy it has a large impact.

This morning France has told us this. From Insee.

In April 2018, households’ confidence in the economic
situation was almost unchanged: the synthetic index
gained one point at 101, slightly above its long-term
average.

So a lot better than the 80 seen in the late spring/summer of 2013 but also a fade from the 108 of last June. Also yesterday we were told this.

The balances of industrialists’ opinion on overall and
foreign demand in the last three months have dropped
sharply compared to January – they had then reached their
highest level since April 2011.

That makes the quarter just gone look like a peak or rather the turn of the year especially if we add in this.

Business managers are also less optimistic about overall and foreign demand over the next three months;

bank lending

The survey released by the ECB yesterday was pretty strong although it tends to cover past trends. Also it seemed to show hints of what we might consider to be the British disease.

Credit standards for loans to households for house purchase eased further in the first quarter of 2018……..In the first quarter of 2018, banks continued to report a
net increase in demand for housing loans

And really?

Net demand for housing loans continued to be driven
mainly by the low general level of interest rates,
consumer confidence and favourable housing market
prospects

Comment

The ECB finds itself in something of a dilemma. This is because it has continued with a highly stimulatory policy in a boom and now faces the issue of deciding if the current slow down is temporary or not? Even worse for presentational purposes it has suggested it will end QE in September just in time for the economic winds to reverse course. Added to this has been the rise in the oil price which will boost inflation which the ECB will say it likes when in fact it must now that it will be a contractionary influence on the economy. This means it is as confused as its namesake ECB in the world of cricket.

Such developments no doubt are the reason why ECB members are on the media wires the day before a policy meeting ignoring the concept of purdah. Also I suspect the regular section on economic reform ( the equivalent of a hardy perennial) at tomorrow’s press conference might be spoken with emphasis rather than ennui. From Reuters.

The European Central Bank, after suffering a political backlash, is considering shelving planned rules that would have forced banks to set aside more money against their stock of unpaid loans. The guidelines, which were expected by March, had been presented as a main plank of the ECB’s plan to bring down a 759 billion euro ($930 billion) pile of soured credit weighing on euro zone banks, particularly in Greece, Portugal and Italy.

Also we return to one of the earliest themes of this website which was that central banks would delay any return to normal monetary policy. Back then I did not know how far they would go and now we wait to see if the ECB will ever fully reverse it’s Whatever it takes” policy or will end up adding to it?

 

 

 

 

Number Crunching and Seigniorage at the ECB

This week has seen a flurry of activity at the ECB or European Central Bank and I do not mean the usual “sauces” which have been raising some doubt about a further reduction in the monthly flow ( currently 30 billion Euros) of QE bond purchases. Let us open with some Brexit bingo from the Financial Times.

Brussels is considering a €56bn raid on European Central Bank profits to plug a hole in the EU’s long-term budget after Brexit.  The European Commission will discuss the plan at its weekly meeting on Wednesday, where it is due to consider a range of new revenue sources as it tries to maintain its financial firepower once the EU’s second-biggest net budget contributor leaves the bloc in 2019.

There is some debate over whether the UK will be the second or third largest net contributor but you get the message. We also get a clear sign of the bureaucratic mind which of course wants more revenue rather than cutting spending in true Sir Humphrey Appleby style. But why not simply get the money from the usual sources ( minus one)?

The commission is considering an ECB cash raid as a quick way to generate money for the common EU pot as several wealthier members, including the Netherlands and Austria, refuse to raise their contributions to the €1tn EU budget after the UK’s departure.

Okay so as they do not want to pay how would it raid the ECB?

The ECB proposal would divert profits made by the eurozone’s 19 national central banks from printing banknotes straight into EU coffers. The commission estimates the revenue stream could generate €56bn during the seven-year span of the next EU budget.

No doubt more than a few of you have spotted what Shakespeare would call the rub here but let me explain.

Seigniorage

This is the profit from issuing money which comes from the fact that if we take the example of the picture of the 50 Euro note it costs a lot less than that to make one. So as it comes off the printing presses hey presto there is a large profit, or rather when someone wants it there is. From the ECB.

They make their way to you via your bank, which pays the face value of the notes to the central bank. To do this your bank usually needs to borrow money from the central bank or it pays by handing over some of its assets. The central bank earns interest on the money it lends, or receives a return on the assets it acquires – and this is called seigniorage income.

To give you an idea the US Federal Reserve calculates it costs some 12.9 cents to make each US $50 note so the note is almost “all gravy” to coin a phrase. A little care is needed as smaller denomination coins actually make a loss – hence the campaigns from time to time to get rid of them – but overall the operation is extremely profitable. However you may note that it is not the capital profits under discussion here ( that presumable can wait for a more desperate time) it is the income from them.

Is anybody else thinking that the campaign to get rid of the 500 Euro note might now have a rethink? Kenneth Rogoff might go from hero ( of the establishment) to zero overnight.

But then we hit a rather large stumbling block.

Although the ECB does not physically issue banknotes, it has been agreed that of all the banknotes in circulation in the euro area, 8% – in terms of value – are considered to be issued by the European Central Bank. The national central banks put the notes into circulation on the ECB’s behalf, and the ECB earns seigniorage income on the 8% through the claim it holds on the national central banks.

Okay before we break that down let us have a break for some humour. From kim in a comment to the FT article.

The ECB takes a cut of the transferred seignorage, to pay for its Christmas Party.

But the 8% is a gift as you see the income goes to the central bank which is each national one.  Oops!

Danger! Will Robinson Danger!

There are consequences here and let me take you back in time to explain them. Let me illustrate from the Maverecon Blog of my tutor from back in the day Willem Buiter from 2009.

The NCBs that own the ECB themselves have a range of formal ownership arrangements, but
are ultimately under the financial control of their national fiscal authorities, because the
national fiscal authority can always tax the NCB.

So we are back in a way to how this story started because the money belongs to the national governments via their treasuries or if you consider belongs to be over playing it they can at least take it via taxation. It is not usually expressed as taxation but we regularly discuss payments from central banks to national treasuries as part of QE declared profits. Most of us would love to be able to declare something “independent” then sing along with the Steve Miller Band.

Go on take the money and run
Go on take the money and run
Go on take the money and run
Go on take the money and run

We of course would sooner or later end up in jail unless we had the wisdom to set up a bank ourselves. But then looking back to 2009 there is this that strikes to the core of the ECB itself.

What makes the ECB more independent than any other central bank is the fact that it has 16 national Treasuries as its counterparties rather than a single national Treasury. Should a European fiscal federal authority ever emerge, the anomaly of the ECB as a de facto as well as a de jure financially independent central bank would probably come to an end.

There are of course some extra treasuries now so it should be even more independent and yet seems set to lose it. My argument with my old tutor would be that politicians are pretty much the same the world over so the situation has always been more like the episode of Star Trek where the USS Enterprise is swallowed by a giant amoeba in my opinion. Of which this is simply the latest step. It should not be true under the rules of mathematics but we know that in human behaviour more can sometimes be less.

The Income

Actually there is a problem here too as the ECB notes.

Seigniorage income has been falling since 2008, in line with a decline in euro area interest rates.

Let me make that clearer because you see at the moment their isn’t any because the current account rate is a grand 0%. Actually contrary to the forecasts above the ECB under Mario Draghi seems in no hurry to raise interest-rates so they could be there for a while and may well survive his term as ECB President. If a recession hits they could cut interest-rates again in which case the European Commission will have shot itself in the foot.

Comment

There are several issues here which go to the heart of an “independent” central bank. Up until now it has operated in concert with the establishment where lower interest-rates and QE have generated gains for the establishment. But the irony of the European Commission proposal would be that it would lose if the ECB cut interest-rates again as seigniorage income would be negative. So suddenly we might find that they are keen on higher interest-rates which is quite a tangled web! It might have been far better if the subject had remained in the text books.

Also there are national issues as some national central banks issue more cash that others under the ECB system. We find ourselves quickly returning to yesterday.

The value of accumulated net issuance of euro banknotes by the Bundesbank rose between the end of 2009 and the end of 2017 from € 348 billion to € 635 billion. Since 2010
On average, the Bundesbank gave an average of € 35.8 billion in euro banknotes a year.
This corresponds to an average annual growth rate of 7.8%.

Or we can put that another way as Lorcan R Kelly does here.

The Bundesbank has, since the introduction of the euro in 2002, put a net 327 billion euros into circulation above its on-paper allocation………In total, 592 billion of the 1.1 trillion euros worth of banknotes in circulation at the end of 2016 started life at the Bundesbank.

The ECB explains this by giving an example of German tourists spending money abroad whereas I am sure I am not the only person who remembers the phase where people were worried about the Euro and therefore keen on “German” Euros as opposed to in the worst case “Greek” ones. Also should interest-rates rise there is a cost as you have to pay if over your allocation.

Should the ECB, over time, raise benchmark interest rates to 2 percent, for example, that would impose an annual cost of 6.5 billion euros on the Bundesbank.

So a transfer to the European Commission what could go wrong. Also if we note that this seems to be something under the aegis of Mr.Juncker he might be able to help out with this.

One more thing worth noting from the data is the position of Luxembourg’s central bank. It has an allocation of less than 3 billion euros and yet has put over 96 billion euros into circulation, and in this case it doesn’t seem like holiday makers are to blame.

So as a final thought is the US Federal Reserve planning a Seigniorage party with its interest-rate rises?

 

Euro area monetary policy heads for a new frontier

The issue of monetary policy in the Euro area is of significance on several levels. Obviously it affects the Euro area itself but also it affects many countries around it as in a nod to the sad departure of Stephen Hawking overnight it is time to sing along with Muse.

Into the supermassive
Supermassive black hole
Supermassive black hole
Supermassive black hole
Supermassive black hole

This has been demonstrated by the way that zero and then negative interest-rates ( a deposit rate of -0.4%) in the Euro has forced others in the locale to follow suit. It was and is a factor in the -0.5% of Sweden the -0.65% certificate of deposit rate in Denmark and the -0.75% of Switzerland amongst others. It is also a factor in the UK still remaining with a Bank Rate of 0.5% after so many years have passed and not following the more traditional route of aping the moves of the US Federal Reserve.

What next?

This is the question on many lips both inside for obvious reasons but also outside the Euro area for the reasons above. Why? Well the President of the European Central Bank Mario Draghi explained this earlier today in Frankfurt.

The economy has been growing consistently above current estimates of potential growth, by more than a percentage point last year. All euro area confidence indicators are close to their highest levels since the start of monetary union, even if the latest readings came in slightly below expectations.

This as I regularly point out means that monetary policy is facing a new frontier. This is because it is procyclical where it is expansionary in an existing expansion. Mario has in fact gone further than me in one area as in his view it is even more procyclical leading to output being more than 1% above potential. If that sounds a little mad I will return to it in a moment.  But another factor in this new frontier is the way that both negative interest-rates and QE have been deployed.

We’ll open up the doors and climb into the dawn
Confess your passion your secret fear
Prepare to meet the challenge of the new frontier ( Donald Fagen)

Potential Output?

Looking at what output has been allows us to figure it out.

Over the whole year 2017, GDP rose by 2.3% in the euro area ( Eurostat)

That would mean that potential output is only 1% per annum but I suspect Mario really means the 2.7% if you compare the last quarter of 2017 with a year before so 1.5%. That is rather downbeat which is very common amongst central bankers these days as for example Governor Carney and the Bank of England used different language “speed limit” for the UK but also came to 1.5%. Due to demographic pressures the Bank of Japan is even more downbeat for Nihon at 1%.

We will see how the media treat that as they make a big deal of the UK situation but let is move onto what causes them to think this? We come to something which is genuinely troubling.

Second, the degree of slack itself is uncertain. Even if slack is now receding, estimates of the size of the output gap have to be made with caution. Strong growth may be leading to higher potential output, as crisis-induced hysteresis may be reversed in conditions of stronger demand. And the effects of past structural reforms, especially in the labour market, may now be showing up in potential output.

As you can see the certainty of earlier has gone as this clearly points out they do not know. We are back to imposing theory on reality again and even worse a failed theory as later we get this.

Phillips curve decompositions find that past low inflation dragged down wage growth from its long-term average by around 0.2 percentage points each year between 2014 and 2017.

If we step back we see that according to the Phillips Curve wages should be soaring as we are above potential output whereas in fact they are doing this.

 The unexplained residuals in the model – which in the past were sizeable – are diminishing, suggesting the link between unemployment and wages should improve.

As in there is no link visible yet but if you inhale enough hopium it will be along at some point! Also I hope you enjoyed the reference to labour market reforms from Mario as we mull the contrast between that and his policy press conferences which every time without fail have a section calling for economic reform.

More! More! More!

It is somewhat awkward when you are telling people the economy is running hot and implying it is overheating if you also say it may be about to run faster.

Non-essential purchases – which make up around 50% of household spending in the euro area – tend to be postponed during recessions and then to catch up as the business cycle advances. Such purchases are currently only 2% above their pre-crisis level, compared with 9% for essential ones. This implies that discretionary household spending still has scope to support the expansion.

So it is below potential Mario? Also an area central bankers love to see boom also seems to be below potential.

Moreover, housing investment is still 17% below its pre-crisis level and is only now starting to pick up, which will likely add an extra impulse to the recovery dynamic.

What about inflation?

This if you look at a Phillips Curve world should be on the march in both senses as wages and prices should be heading upwards and yet.

Wage growth has been trending upwards for the euro area as a whole, rising by 0.5 percentage points from the trough in mid-2016.

Not much is it? As to be fair Mario points out.

But consistent with the weakening of the relationship between slack and inflation, the adjustment of wages during the recovery has so far been atypically slow.

The trouble is the analysis seems to be based on pure hopium.

That said, our analysis suggests that, as the cycle advances, the standard wage Phillips curve should hold better for the euro area on average. The unexplained residuals in the model – which in the past were sizeable – are diminishing, suggesting the link between unemployment and wages should improve.

So when you really want it to work ( in a crisis) it fails and in calmer times it does not seem to work either. But they will continue with it anyway like someone who s stuck in the mud.

Comment

Actually I think that Mario Draghi is more intelligent than this as we see several themes come together. Back in the dim and distant days when I began Notayesmanseconomics I offered the opinion that central bankers would dither when it became time to reverse course on their stimuli. This became a bigger factor as the stimuli grew. Now we see a central banker telling us.

But we still need to see further evidence that inflation dynamics are moving in the right direction. So monetary policy will remain patient, persistent and prudent.

This works nicely for Mario as the inflation forecasts remain below the 1.97% inflation target defined by a predecessor of his ( Monsieur JC Trichet).

The latest ECB projections foresee a pickup in headline inflation from an average rate of 1.4% this year to 1.7% in 2020.

Thus as he has hinted at in past speeches which more than a few seem to have forgotten Mario Draghi may depart as ECB President without ever raising interest-rates. In fact it seems to be his plan and it is something he will leave as a “present” for whoever follows him. Another form of stimulus may have slowed but is still around as well.

The cumulative redemptions under the asset purchase programme between March 2018 and February 2019 are expected to be around EUR 167 billion. And reinvestment amounts will remain sizeable thereafter.

So now we see that policy has been decided and a theory ( Phillips Curve ) has been chosen which is convenient. Mario may not believe it either but it suits his purpose as does claiming their has been labour market reform. This is the same way that we have switched from the economic growth of the “Whatever it takes” speech to inflation now both suggest the same policy which allows Mario to give himself a round of applause.

 Considering all of the monetary measures taken between mid-2014 and October 2017, the overall impact on euro area growth and inflation is estimated, in both cases, to be around 1.9 percentage points cumulatively for the period between 2016 and 2019.

So another masterly performance from Mario Draghi but it should not cover up the many risks from advancing onto a new frontier of procyclical monetary policy.

 

 

 

 

The economy of Italy has yet to awaken from its “Girlfriend in a coma” past

The subject of Italy and its economy has been a regular feature on here as we have observed not only its troubled path in the credit crunch era but also they way that has struggled during its membership of the Euro. This will no doubt be an issue in next month’s election but the present period is one which should be a better phase for Italy. Firstly the Euro area economy is doing well overall and that should help the economy via improved exports.

Seasonally adjusted GDP rose by 0.6% in both the euro area (EA19) and in the EU28 during the fourth quarter of
2017, compared with the previous quarter……..Compared with the same quarter of the previous year, seasonally adjusted GDP rose by 2.7% in the euro area and
by 2.6% in the EU28 in the fourth quarter of 2017…….Over the whole year 2017, GDP grew by 2.5% in both zones.

The impact on the economy of Italy

If we switch now to the Italian economy we find that there has been a boost to the economy from the better economic environment. From the monthly economic report.

Italian exports keep increasing with a positive trend following world trade expansion…….Over the period September-November, foreign trade kept a positive trend
driven by the exports (+2.9%), while the imports increased at a lower pace (+0.6%).

However the breakdown was not as might be expected.

Sales to the non-EU area (+4.6%) contributed positively to the favorable trend in exports and more than the sales to the EU area (+1.5%). In 2017, trade with non-EU countries increased both exports (+8.2%) and imports (+10.8%).

So the export-led growth is stronger outside the Euro area than in it which is not what we might expect as we observe the way that the Euro has been strong as a currency. Effects in this area can be lagged so it is possible via factors such as the J-Curve that the new higher phase for the Euro has yet to kick in in terms of its impact on trade, so we will have to watch this space.

Production

There was some good news on this front in December as the previous analysis had been this.

Taking the average values of September-November, shows that production decreased compared to the previous quarter (-0.2%, ). In the same period all the main industrial groupings recorded a decrease except durable consumer goods (+2.7% compared to the previous quarter).

As you can see that is not what might have been expected but last weeks’ data for December was more upbeat.

In December 2017 the seasonally adjusted industrial production index increased by 1.6% compared with the previous month. The percentage change of the average of the last three months with respect to the previous three months was +0.8.

This meant that the position for the year overall looked much better than the downbeat assessment above.

in the period January-December 2017 the percentage change was +3.0 compared with the same period of
2016.

If we move to the outlook for 2018 then the Markit business survey or PMI could not be much more upbeat.

Italy’s manufacturing sector enjoyed a strong start
to 2018, registering the highest growth in output
since early 2011 and one of the greatest rises in
new orders of the past 18 years.

In addition domestic demand was seen adding to the party.

but January data pointed to a growing contribution from within Italy itself.

This leads to hopes for improvement in one of the Achilles heels of the Italian economy.

The response from many manufacturers was to
bolster employment numbers, and January’s survey
indicated the second-strongest rise of employment
in the survey history.

Unemployment and the labour market

At first glance the latest data does not look entirely impressive.

In December 2017, 23.067 million persons were employed, -0.3% over November 2017. Unemployed were
2.791 million, -1.7% over the previous month.

There is a welcome fall in unemployment but employment which these days is often a leading indicator for the economy has dipped too.

Employment rate was 58.0%, -0.2 percentage points over the previous month, unemployment rate was
10.8% -0.1 percentage points over November 2017 and inactivity rate was 34.8%, +0.3 percentage points in
a month.

However if we look back we see that over the past year 173,000 more Italians have been employed and the level of unemployment has fallen by 273,000.  What we are still waiting for however is a clear drop in the unemployment rate which has been stuck around 11% for a while. We are told it has dropped to 10.8% but there has been a recent habit of revising the rate back up to 11% at a later date meaning we have been told more than a few times that it has fallen below it. Sadly much of the unemployment is concentrated at the younger end of the age spectrum.

Youth unemployment rate (aged 15-24) was 32.2%, -0.2 percentage points over the previous month.

So better than Greece but isn’t pretty much everywhere as we again wonder how many of these have never had a job and even more concerning, how many never will?

Sometimes we are told that higher unemployment rates are a consequence of better wages. But is we look at wages growth there does not seem to be much going on here.

The labor market outlook is characterized by the wage
moderation: in 2017 both the index of contractual wages per employee and that of hourly wages increased by +0.6% y-o-y.

On a nominal level that is a fair bit below even the UK but of course the main issue is in real or inflation adjusted terms.

In January 2018, according to preliminary estimates, the Italian consumer price index for the whole nation (NIC) increased by 0.2% on monthly basis and by 0.8% compared with January 2017 (it was +0.9% in December 2017).

So there was in fact a small fall in real wages in 2017 which we need to file away on two fronts. Firstly there is the apparent fact that better economic conditions in Italy are not being accompanied by real wage growth and in fact a small fall. Secondly we need to add that rather familiar message to our global database.

The banks

This is a long running story of how the banking sector carried on pretty much regardless after the credit crunch and built up a large store of non-performing assets or if you prefer bad loans. This has meant that many Italian banks are handicapped in terms of lending to help the economy and some have become zombified. From Bloomberg earlier.

Even after making reductions last year, Italian banks are still weighed down by more than 270 billion euros ($330 billion) of non-performing loans. Struggling households account for almost a fifth of that total, according to the Bank of Italy.

It is hard not to have a wry smile at a proposed solution.

The Bank of Italy says an improvement in the country’s real estate market is helping to reduce the risks for banks.

Whether that will do much good for what has become the symbol of the problem I doubt but here is the new cleaner bailed out Monte Paschi. From Bloomberg on Monday.

The bank, which is cutting about a fifth of its workforce, eliminating branches and plans to sell 28.6 billion euros of bad loans by 2021, posted 501.6 million-euro net loss in the last three months of the year.

How is the bailout going?

The shares were down 2.8 percent at 3.72 euros as of 9:55 a.m. The stock, which returned to trading Oct. 25 after an 10-month suspension, is now valued more than 43 percent below the 6.49 euros apiece paid by Italy for the rescue.

This morning it is 3.44 Euros so the beat goes on especially as we note that pre credit crunch and the various bailouts the equivalent price peak was over 8800.

Demographics

This issue continues to be ongoing.

The population at 1st January 2018 is estimated to be 60,494,000; the decrease on the previous year was
around 100,000 units (-1.6 per thousand).

Driven by this.

The number of live births dropped to 464 thousand, 2% less than in 2016 and new minimun level ever.

We have seen on the news so often that there is considerable migration to Italy and if we look into the detail we see that not only is it so there is something tucked away in it.

The net international migration in 2017 amounted to +184 thousand, recording a consistent increase on the
previous year (+40 thousand).

Yet Italians themselves continued to leave in net terms as 45,000 returned but 112,000 left which is a little surprising in the circumstances. As to the demographics well here they are.

At 1 January 2018, 22.6% of the population was aged 65 or over, 64.1% was aged between 15 and 64, while
only 13.4% was under 15 years of age. The mean age of the population exceeded 45 years.

The theme is that the natural change has got worse over the past decade rising from pretty much zero to the 183,000 of 2017 but contrary to the news bulletins net immigration is lower as it approached half a million in 2007.

Comment

This morning has brought news which will be very familiar to readers of my work which is an Italian economy which seems to struggle to grow at more than around 1% per annum for any sustained period.

In the fourth quarter of 2017 the seasonally and calendar adjusted, chained volume measure of Gross
Domestic Product (GDP) increased by 0.3 per cent with respect to the third quarter of 2017 and by 1.6 per
cent in comparison with the fourth quarter of 2016.

As we note a negative official interest-rate ( -0.4%) and a large amount of balance sheet expansion from the European Central Bank the monetary taps could not be much more open. Italy’s government in particular benefits directly by being able to borrow very cheaply ( ten-year yield 2.05%) when you consider it has a national debt to annual GDP ratio of 134.1%. Thanks Mario!

Thus we return on Valentines Day to the “Girlfriend in a Coma” theme of Bill Emmott which is a shame as Italy is a lovely country. Can it change? Let us hope so and maybe the undeclared economy can be brought to task. Meanwhile if you want to take the Matrix style blue pill here is Bloomberg.

ITALY: GDP expanded by 0.3% in 4Q, a bit less than expected. Still, 2017 was the best growth year (+1.5%) since 2010. Shows how broad-based the euro-area recovery has become. A rising tide lifts all boats