Eurozone leaders met at a summit in Brussels on 28 and 29 June. Expectations ahead of the summit were low that any significant progress would be made on supporting eurozone banks and governments, on achieving more effective bank regulation or stimulating economic growth.
For once, EU leaders surprised markets by reaching a more comprehensive agreement than anticipated. The agreement has five key elements:
1. The use of funds from the soon-to-be launched eurozone bailout fund, the European Stability Mechanism (ESM), to lend to banks directly. Previously, funds had been made available to national governments to lend to their banks. This, however, increased the debts of the national governments, such as Spain, which made it harder for them to meet deficit and debt targets.
2. The setting up of a new banking supervisory body to impose common standards, such as capital adequacy requirements, on banks across the eurozone.
3. The use of the eurozone bailout fund to buy government bonds on the secondary market, provided governments are sticking to agreed deficit reduction measures. This would help to reduce interest rates on government bonds in countries such as Spain, Italy and Greece, currently having to pay interest rates 5 or 6 percentage points above those on German bonds.
4. A €120bn growth package to target EU money at small businesses, youth unemployment and infrastructure improvements. Most of the money would be from existing funds, such as EU Structural Funds, which are currently unused. There would be some additional funds, however, including €10bn to boost the lending capacity of the European Investment Bank.
5. A 10-year ‘roadmap’ towards greater fiscal union, including the creation of a eurozone treasury, which could limit overall spending by national governments.
Generally the agreement has been greeted positively, with stock markets in the eurozone and across the world rising significantly. But will the measures be enough to reassure investors over the coming weeks? Will they cure the problems of the eurozone or are they just one more, albeit larger, sticking plaster?
The following webcasts, podcasts and articles look at the agreement and the resulting prospects for the eurozone.
Webcasts and podcasts
Eurozone bends the rules to save single currency euronews (29/6/12)
Markets Like Euro Crisis Deal, Merkel Defensive Associated Press (29/6/12)
Eurozone crisis: ‘Breakthrough’ at summit BBC News, Gavin Hewitt (29/6/12)
EU summit outcome exceeds – low – expectations euronews (29/6/12)
Italy and Spain are main beneficiaries after EU summit euronews (30/6/12)
EU bank aid deal ‘better than expected, worse than needed’ euronews (29/6/12)
New eurozone deal ‘not enough’ BBC Today Programme, James Shugg (29/6/12)
Eurozone: ‘Massive concession’ from Angela Merkel BBC Today Programme, Gavin Hewitt and Robert Peston (29/6/12)
Articles
Eurozone bank bailout deal throws lifeline to Spain and Italy Guardian, Ian Traynor and Phillip Inman (29/6/12)
Spain lifeline after EU allows direct access to eurozone bailout funds Guardian (29/6/12)
Less disunion The Economist, Charlemagne’s notebook (29/6/12)
Eurozone agrees on bank recapitalisation BBC News (29/6/12)
Merkel defends compromise deal on eurozone banks BBC News (29/6/12)
A first, tentative step to salvation for the eurozone Independent, Leading article (29/6/12)
Analysis – Sharing a vision may be Europe’s biggest challenge Reuters, Alan Wheatley (3/7/12)
Eurozone bank agreement welcomed FT Adviser, Rebecca Clancy & Bradley Gerrard (2/7/12)
The real victor in Brussels was Merkel Financial Times, Wolfgang Münchau (1/7/12)
Finns, Dutch cast first doubt on EU summit deal EurActiv (3/7/12)
A Euro deal from Brussels BBC News, Stephanie Flanders (29/6/12)
Document
Conclusions of the European Council (28/29 June 2012) European Council (29/6/12)
Questions
- What are the advantages of the ESF lending to banks directly? Are there any problems associated with the proposal?
- To what extent will the measures solve the problems of the eurozone? What else might need to be done?
- Are there any potential moral hazards contained in the proposals and how are they likely to be tackled?
- Explain the concept of ‘seniority’ in the following statement: “the debt owed by Spain to the EFSF, if and when it is transferred to the ESM, will not gain seniority”. Why might this be good for private financiers?
- If governments’ bonds are to be purchased by the ESM, what conditions are likely to be attached?
With the deepening euro crisis, the slide back into recession in many developed countries and the slowing down of fast-growing developing countries, such as China and India, confidence is waning.
But just as pessimism increases, so too does uncertainty. The global economy is getting more and more difficult to forecast. So should economists give up trying to forecast? Should we rely on guesswork and hunch, or looking into crystal balls?
Bank of England representatives have been appearing before the Treasury Select Committee. And they have reiterated the consensus that things are getting more difficult to forecast. As Mervyn King said in his evidence:
There is just enormous uncertainty out there. I have no idea what is going to happen in the euro area.
And this uncertainty is making people cautious, which, in turn, damages recovery. As Dr King went on to say:
There is no doubt that with the additional uncertainty this year there’s evidence of people behaving in a very defensive way, being unwilling to invest and of course the most extreme example of that would be if we were to get to a liquidity trap where essentially the main assets people wanted to hold were claims on the central bank.
Part of the reason for the uncertainty about global growth prospects is uncertainty about what European leaders will decide about the future of the eurozone. Another is uncertainty about how people will respond to the uncertainty of others. But predicting how others will predict is very difficult as they will themselves be predicting what others will predict. This dilemma was observed by Keynes when observing how investors on the stock market behaved, all trying to predict what others will do, and is known as the Keynesian Beauty Contest dilemma (see also).
So are governments and central banks powerless to counteract the uncertainty and pessimism? Can they restore confidence and growth? Members of the Bank of England’s Monetary Policy Committee believe that further action can be taken to stimulate aggregate demand. Further quantitative easing and cuts in interest rates could help as, according to Dr King, we are not yet in a liquidity trap.
UK Economic Outlook Uncertain Amid Euro Zone Crisis – BOE NASDAQ, Ilona Billington (26/6/12)
BOE King: UK Not In Liquidity Trap; No Limit On QE Market News International (26/6/12)
BOE King: Unity On Loose Policy; Not Half Way Through Crisis Market News International (26/6/12)
Full Text Of BOE MPC Dale At Treasury Select Committee Market News International (26/6/12)
Recovery still five years away, Mervyn King warns The Telegraph, Philip Aldrick (26/6/12)
Governor pessimistic on recovery ShareCast, Michael Millar (26/6/12)
Bank’s King says ‘pessimistic’ about worsening economy BBC News (26/6/12)
UK economic outlook getting worse, warns Bank of England Guardian, Phillip Inman (26/6/12)
Questions
- Why is it worth economists forecasting, even if those forecasts rarely turn out to be totally accurate?
- Why is it particularly difficult in current circumstances to forecast the state of the macroeconomy 12 months hence – let alone in two or three years?
- In what ways is the global macroeconomic situation deteriorating? What can national governments do about it?
- What limits the effectiveness of government action to deal with the current situation?
- What is meant by the liquidity trap? Are we close to being in such a situation today?
- Explain what is meant by the Keynesian Beauty Contest? How is this relevant today in explaining economic uncertainty and the difficulty of forecasting the economy?
With falling GDP and house prices, Spanish banks have been running the risk of failure. Indeed, the Spanish government has already had to agree to bail out Spain’s fourth biggest bank, Bankia.
On Saturday 9 June, at a crisis conference call, eurozone finance ministers agreed to lend the Spanish government up to €100 billion to provide credit to Spanish banks. The Spanish government is commissioning independent audits of the banks and, in the light of that, will specify just how much it needs to borrow.
Details of the nature of the loans will be made clear over the coming days, but they will funded either from the temporary rescue fund, the European Financial Stability Facility (EFSF), or from the new permanent fund that will replace it, the European Stability Mechanism (ESM).
But whilst the loans will remove the immediate pressure on Spanish banks, the underlying problems of the Spanish economy remain. Easy credit fuelled a property bubble which then burst. House prices have fallen by over 20% since the peak, and many Spanish people are in negative equity. Many construction companies have gone out of business.
What is more, the Spanish government is committed to reducing the budget deficit from 8.9% of GDP in 2011 to 5.3% in 2012 and 3% in 2013. To achieve this it has instituted tough austerity policies of government expenditure cuts and tax rises. (Click here for a link to a graph from the BBC of budget deficits in 18 EU countries.)
This has only aggravated the decline in GDP – at least in the short term. Spanish GDP is set to fall by around 2% this year and unemployment, at nearly 25% and rising, is the highest in Europe. Indeed the unemployment rate for those aged 15 to 25 is over 51%! This clearly has profound social and political consequences, with many young people seeing no prospect of gaining employment and thus feeling socially alienated. (For a PowerPoint of the above chart, click here.)
Markets on the Monday after the bailout was announced initially reacted positively. By the end of the day, however, the gains had been wiped out. Although no conditions were imposed on the Spanish government – the loan, although to the Spanish government, was to bail out the banks, not the government itself – worries remain that the Spanish economy is not set to recover for some time.
What is more, worries about other eurozone countries in difficulty have not gone away. Indeed, with the Spanish government being seen as having been dealt with more leniently than the Greek, Portuguese and Irish governments, investors are now worried that these countries may demand to renegotiate the terms of their bailout. And in the case of Greece, the Spanish bailout may make people more willing to vote in this coming Saturday’s election for parties that reject the Greek bailout terms. This may make it more likely that Greece will be forced to leave the euro, with all the chaos that is likely to ensue.
Webcasts and Podcasts
Spain: Simmering anger in Seville BBC News, Paul Mason (7/6/12)
Will Spain’s Bailout save Europe? CNBC Video, Martin Wolf (11/6/12)
Bailout boost evaporates Financial Times video, James Macintosh (11/6/12)
Spain’s bailout may not be enough Financial Times video, Nikki Tait (11/6/12)
Eurozone: ‘Italy will be next’ BBC Today Programme, Robert Peston (11/6/12)
Articles
Eurozone agrees to lend Spain up to 100 billion euros MSN Money, Jan Strupczewski and Julien Toyer (12/6/12)
Hurried Spanish banking bailout fails to calm market nerves Guardian, Giles Tremlett (11/6/12)
Fears that Spain’s bailout relief may be short-live Independent, Alasdair Fotheringham and Tom Bawden (11/6/12)
Spanish banks deal: Market concerns remain BBC News (11/6/12)
Q&A: Spanish bank deal BBC News (11/6/12)
Debt crisis: Market euphoria evaporates over Spain’s €100bn bank bailout The Telegraph, Emma Rowley and Bruno Waterfield (11/6/12)
Why bondholders are scared about Spain MarketWatch, Deborah Levine (11/6/12)
Krugman on another bank bailout Press-Telegram Paul Krugman (11/6/12)
Messy Spanish rescue BBC News, Robert Peston (10/6/12)
This latest euro fix will come apart in less than a month The Telegraph, Jeremy Warner (11/6/12)
The consequences of Spain’s bank rescue Financial Times, Gavyn Davies (10/6/12)
Buy on the summit, sell on the communiqué Financial Times, Alan Beattie (11/6/12)
The vicious euro circle keeps turning BBC News, Stephanie Flanders (12/6/12)
Spanish banks need up to 62bn euros BBC News (21/6/12)
Eurozone crisis explained BBC News (19/6/12)
Spain formally requests a bailout for its banks BBC News (25/6/12)
Documents and press releases
IMF Says Spain’s Core Financial System is Resilient, but Important Vulnerabilities Remain IMF Press Release (8/6/12)
Spain and the IMF IMF links to various documents including: Spain – Financial System Stability Assessment (8/6/12)
Eurogroup statement on Spain Eurozone Portal, The Eurogroup (9/6/12)
Questions
- How does the Spanish bailout differ from those for Greece, Irelend and Portugal?
- What are the likely implications for Spanish borrowing costs of the loans coming from the ESM?
- To what extent does the plan to bail out Spanish banks involve a moral hazard?
- What is likely to be the effect of the Spanish bailout on Greece, Ireland and Portugal?
- How bad is Spanish public-sector debt compared with other countries? What is the likely effect of the bailout on Spanish public-sector debt?
- What is meant by a banking union in the eurozone and how would it work? What would be the implication of a eurozone banking union for the UK?
Oil prices have been falling in recent months. By early June they had reached a 17-month low. The benchmark US crude price (the West Texas Intermediate price) fell to $83.2 at the beginning of the month, and Brent Crude (the North Sea reference price for refining into petrol) fell to $97.7 (see chart). (For a PowerPoint of the chart below, click here.)
At the same time various commodity prices have also been falling. The IMF all commodities price index has fallen by 7.2% over the past 12 months and by 6.2% in May alone. Some commodities have fallen much faster. In the 12 months to May 2012, natural gas fell by 44%, wheat by 25%, lamb by 37%, Arabica coffee by 36%, coconut oil by 45%, cotton by 47%, iron ore by 23% and tin by 29%.
Although part of the reason for the fall in the price of some commodities is increased supply, the main reason is weak world demand. And with continuing problems in the eurozone and a slowdown in China and the USA, commodity price weakness is likely to continue.
So is this good news? To the extent that commodity prices feed through into consumer prices and impact on the rate of inflation, then this is good news. As inflation falls, so central banks will be encouraged to make further cuts in interest rates (in the cases where they are not already at a minimum). For example, the Reserve Bank of Australia cut its cash rate last week from 3.75% to 3.5%. This follows on from a cut from 4.25% on 1 May. In cases where there is no further scope for interest rate cuts (e.g. the US Federal Reserve Bank, whose interest rate is between 0% and 0.25%), then the fall in inflation may encourage a further round of quantitative easing.
But falling commodity prices are also a reflection of bad news, namely the low economic growth of the world economy and fears of turmoil from a possible Greek exit from the euro.
Update
A day after this was written (9/6/12), a deal was agreed between eurozone ministers to provide support of up to €100 billion for Spanish banks. This helped to reduce pessimism about the world economy, at least temporarily. Stock markets rose and so too did oil prices, by around 1%. But if pessimism increases again, then the fall is likely to resume.
Articles
Oil prices hit a 17-month low on China slowdown fears BBC News (8/6/12)
Oil gives up gains without signs of Fed move BloombergBusinessweek, Sandy Shore (7/6/12)
Oil Heads for Longest Run of Weekly Losses in More Than 13 Years BloombergBusinessweek, (8/6/12)
Gold plunges as Bernanke gives no hint of stimulus Live5News(7/6/12)
Oil Price Tumbles Below $83 on Weak Economy Money News(8/6/12)
World food price index expected to fall for May Reuters(6/6/12)
Oil price losing streak continues Guardian, Julia Kollewe (8/6/12)
Data
Spot fuel prices US Energy Information Administration
Commodity Prices Index Mundi
Crude Oil Price Index Index Mundi
Questions
- Why have crude oil prices fallen to their lowest level for 17 months?
- How can the concepts of income elasticity of demand, price elasticity of supply and price elasticity of demand help to explain the magnitude of the fall in crude oil prices?
- Would a fall in inflation linked to a fall in commodity prices be a fall in cost-push or demand-pull inflation? Explain.
- What are the macroeconomic implications of the fall in crude oil prices?
- What factors are likely to have significant impact on crude oil prices in the coming months
- Why is it difficult to predict crude oil prices over the coming months?
Paul Volcker was Chair of the US Federal Reserve from 1979 to 1987. He was also Chair of the Economic Recovery Advisory Board under President Barack Obama from February 2009 to January 2011. In the webcast and articles below, he reflects on the current state of the world financial system – from regulation, to the euro crisis, to world imbalances, to the system of floating exchange rates.
He argues that global financial systems are vulnerable to breakdowns. What is needed is reform to the system, and for that there needs to be consensus by politicians, regulators and central banks.
But, in the absence of international consensus on some key points, reform will be greatly weakened, if not aborted. The freedom of money, financial markets and people to move – and thus to escape regulation and taxation – might be an acceptable, even constructive, brake on excessive official intervention, but not if a deregulatory race to the bottom prevents adoption of needed ethical and prudential standards.
Perhaps most important is a coherent, consistent approach to dealing with the imminent failure of “systemically important” institutions. Taxpayers and governments alike are tired of bailing out creditors for fear of the destructive contagious effects of failure – even as bailouts encourage excessive risk-taking.
According to Volcker, countries must be prepared to surrender some sovereignty. Policies must be co-ordinated internationally and there must be stronger regulation by international bodies, such as the IMF and stronger concerted action by global organisations, such as the G20.
Left to their own devices, in an era of floating exchange rates, countries may pursue policies that exacerbate global imbalances.
Not so long ago, we were comforted by theorising that floating exchange rates would mediate international adjustments in a timely and orderly way. But, in the real world, many countries, particularly but not limited to small, open economies, simply find it impractical or undesirable to permit their currency to float.
We are left with the certainty, however awkward, that active participation in an open world economy requires some surrender of economic sovereignty. Or, to put the point more positively, it requires a willingness to co-ordinate policies more effectively.
Webcast
Volcker Urges Global Monetary System Overhaul BloombergBusinessweek (31/5/12)
Articles
Is global financial reform possible? Guardian, Paul Volcker (6/6/12)
Volcker Urges Global Financial System Overhaul After Crisis BloombergBusinessweek, Robyn Meredith and Shamim Adam (31/5/12)
Questions
- What reforms, according to Volcker, need to be implemented in order for the euro to function effectively without crises?
- What can the USA do to ease the euro crisis?
- What are Volcker’s views on the regulation of the US banking system?
- How are incentive structures in banks related to speculative activities?
- Should banks be allowed to fail?
- What financial imbalances exist between countries?
- What international monetary reforms are required?
- What light can game theory shed on the difficulty of achieving global policy co-ordination?
- Is an international system of floating exchange rates appropriate given the size of international financial flows?
Eurozone leaders met at a summit in Brussels on 28 and 29 June. Expectations ahead of the summit were low that any significant progress would be made on supporting eurozone banks and governments, on achieving more effective bank regulation or stimulating economic growth.
