Pearson - Always learning

All your resources for Economics

RSS icon Subscribe | Text size

Posts Tagged ‘three arrows’

Don’t bank on Italy’s economy

The Brexit vote has caused shockwaves throughout European economies. But there is a potentially larger economic and political problem facing the EU and the eurozone more specifically. And that is the state of the Italian banking system and the Italian economy.

Italy is the third largest economy in the eurozone after Germany and France. Any serious economic weaknesses could have profound consequences for the rest of the eurozone and beyond.

At 135% of GDP, Italy’s public-sector debt is one the highest in the world; its banks are undercapitalised with a high proportion of bad debt; and it is still struggling to recover from the crisis of 2008–9. The Economist article elaborates:

The adult employment rate is lower than in any EU country bar Greece. The economy has been moribund for years, suffocated by over-regulation and feeble productivity. Amid stagnation and deflation, Italy’s banks are in deep trouble, burdened by some €360 billion of souring loans, the equivalent of a fifth of the country’s GDP. Collectively they have provisioned for only 45% of that amount. At best, Italy’s weak banks will throttle the country’s growth; at worst, some will go bust.

Since 2007, the economy has shrunk by 10%. And potential output has fallen too, as firms have closed. Unemployment is over 11%, with youth unemployment around 40%.

Things seem to be coming to a head. As confidence in the Italian banking system plummets, the Italian government would like to bail out the banks to try to restore confidence and encourage deposits and lending. But under new eurozone rules designed to protect taxpayers, it requires that the first line of support should be from bondholders. Such support is known as a ‘bail-in’.

If bondholders were large institutional investors, this might not be such a problem, but a significant proportion of bank bonds in Italy are held by small investors, encouraged to do so by tax relief. Bailing in the banks by requiring bondholders to bear significant losses in the value of their bonds could undermine the savings of many Italians and cause them severe hardship, especially those who had saved for their retirement.

So what is the solution? Italian banks need recapitalising to restore confidence and prevent a more serious crisis. However, there is limited scope for bailing in, unless small investors can be protected. And eurozone rules provide little scope for government funding for the banks. These rules should be relaxed under extreme circumstances. At the same time, policy needs to focus on making Italian banking more efficient.

Meanwhile, the IMF is forecasting that Italian economic growth will be less than 1% this year and little better in 2017. Part of the problem, claims the IMF, is the Brexit vote. This has heightened financial market volatility and increasead the risks for Italy with its fragile banking system. But the problems of the Italian economy run deeper and will require various supply-side policies to tackle low productivity, corruption, public-sector inefficiency and a financial system not fit for purpose. What the mix of these policies should be – whether market based or interventionist – is not just a question of effectiveness, but of political viability and democratic support.

Articles
The Italian Job The Economist (9/7/16)
IMF warns Italy of two-decade-long recessionThe Guardian, Larry Elliott (11/7/16)
Italy economy: IMF says country has ‘two lost decades’ of growth BBC News (12/7/16)
What’s the problem with Italian banks? BBC News, Andrew Walker (10/7/16)
Why Italy’s banking crisis will shake the eurozone to its core The Telegraph, Tim Wallace Szu Ping Chan (16/8/16)
If You Thought Brexit Was Bad Wait Until The Italian Banks All Go Bust Forbes, Tim Worstall (17/7/16)
In the euro zone’s latest crisis, Italy is torn between saving the banks or saving its people Quartz, Cassie Werber (13/7/16)
Why Italy could be the next European country to face an economic crisis Vox, Timothy B. Lee (8/7/16)
Forget Brexit, Quitaly is Europe’s next worry The Guardian, Larry Elliott (26/7/16)

Report
Italy IMF Country Report No. 16/222 (July 2016)

Data
Economic Outlook OECD (June 2016) (select ‘By country’ from the left-hand panel and then choose ‘Italy’ from the pull-down menu and choose appropriate time series)

Questions

  1. Can changes in aggregate demand have supply-side consequences? Explain.
  2. Explain why there may be a downward spiral of asset sales by banks.
  3. How might the principle of bail-ins for undercapitalised Italian banks be pursued without being at the expense of the small saver?
  4. What lessons are there from Japan’s ‘three arrows’ for Italy? Does being in the eurozone constrain Italy’s ability to adopt any or all of these three categories of policy?
  5. Why may the Brexit vote have more serious consequences for Italy than many other European economies?
  6. Find out what reforms have already been adopted or are being pursued by the Italian government. How successful are they likely to be in increasing Italian growth and productivity?
  7. What external factors are currently (a) favourable, (b) unfavourable to improving Italian growth and productivity?
Share in top social networks!

Japan’s arrows missing their target

Since coming to office two years ago, Shinzo Abe’s government has been determined to revive the Japanese economy. The policy has involved ‘three arrows‘: expansionary fiscal policy, expansionary monetary policy and supply-side reforms. But figures just out show that the Japanese economy is back in recession. The economy shrank by 0.4% in quarter 3, having shrunk by 1.9% in quarter 2.

This has come as a huge disappointment for Mr Abe, who has staked his political reputation on escaping from deflation and achieving sustained economic growth. In response, he has called a general election to put a revised economic plan to the electorate.

The main cause of the reversal into recession has been an increase in the sales tax on all goods, which has dampened spending. The tax rise, planned by the previous government, was to help reduce the deficit and start tackling the huge public-sector debt, which, at over 230% of GDP, is by far the highest in the developed world. Another rise in sales tax is due in October 2015 – from 8% to 10%. Mr Abe hopes to cancel the rise and it is this that he may put to the electorate.

So what is the outlook for Japan? Will quarter 4 show economic growth, or will pessimism have set in? Will the Bank of Japan introduce even more quantitative easing, or will it wait for the latest increase in QE to take effect (see the blog post, All eased out: at least for the USA and UK)?

The following articles look at the implications of the latest news, both for Japan and globally, and at the options for the government and central bank.

Articles
Japanese economy falls into surprise recession Independent, Maria Tadeo (17/11/14)
Japan’s economy makes surprise fall into recession BBC News (17/11/14)
Coming to a crunch: Time is running out for Abenomics The Economist (20/11/14)
Japan’s economy: Delay the second consumption tax hike The Economist (17/11/14)
Defying Expectations, Japan’s Economy Falls Into Recession New York Times, Jonathan Soble (16/11/14)
Japan shocks as economy slips into recession CNBC, Li Anne Wong (17/11/14)
Japan Unexpectedly Enters Recession as Abe Weighs Tax: Economy Bloomberg, Keiko Ujikane and Toru Fujioka (17/11/14)
The world should be wary: Japan’s economic woes are contagious The Guardian, Larry Elliott (17/11/14)
Why is Japan heading to the polls? BBC News (18/11/14)

Previous news items on this site
A new economic road for Japan? (January 2013)
A J-curve for Japan? (May 2013)
Japan’s three arrows (June 2013)
Abenomics – one year on (December 2013)
Japan’s recovery (January 2014)
Japan’s CPI: An Update (May 2014)
All eased out: at least for the USA and UK (November 2014)

Data
Quarterly Estimates of GDP Japanese Cabinet Office
Japan and the IMF IMF Country Reports
Economic Outlook Annex Tables OECD

Questions

  1. Give details of the Japanese government’s three arrows.
  2. Discuss the pros and cons of the rise in the sales tax. Is it possible for the rise in the sales tax to increase the size of the public-sector deficit?
  3. What have been the effects of Japanese government policies on (a) prices of goods and services; (b) living standards; (c) asset prices?
  4. Who have been the gainers and losers of the policies?
  5. How is the Japanese situation likely to effect the value of the yen? How is this, in turn, likely to affect its trading partners? Could this set off a chain reaction?
Share in top social networks!