The eurozone recorded 0.0% growth in the second quarter of 2014. While the UK and USA are now experiencing relatively buoyant economic growth, the eurozone as a whole is stagnating. Some of the 18 eurozone countries, it is true, are now growing, including Spain, Portugal, Ireland and the Netherlands. But the German and Italian economies contracted in the three months to the end of June, while France experienced zero growth.
This will put growing pressure on the ECB to introduce quantitative easing (QE) through the direct purchase of government bonds or other assets. Although this has been a key policy of many central banks, including the Bank of England, the Fed and the Bank of Japan, up to now the ECB has focused mainly on providing cheap funds to banks to encourage them to lend and keeping interest rates very low.
In June, the ECB did announce that it would explore the possibility of QE. It would also introduce €400 billion worth of targeted long-term lending to banks (targeted longer-term refinancing operations (TLTROs)), and would cease sterilising the extra liquidity injected through the Securities Markets Programme, which involved the purchase of existing bonds on the secondary market.
These plans and their implications are examined in the blog post, The ECB: tackling the threat of deflation.
But even if it does eventually introduce QE, this is unlikely before 2015. However, the first €200 billion of TLTROs will be introduced in September and the remaining €200 billion in December. The ECB hopes that these measures in the pipeline will give a sufficient stimulus to rekindle economic growth. But increasingly there are calls for something more dramatic to be done to prevent the eurozone as a whole slipping back into recession.
Articles
Eurozone economy grinds to halt even before Russia sanctions bite Reuters, Michelle Martin and Martin Santa (14/8/14)
ECB under pressure to boost growth, analysts say BBC News (14/8/14)
Eurozone growth at zero as Germany slumps, France stagnates Deutsche Welle (14/8/14)
Eurozone crisis: The grim economic reality BBC News, Gavin Hewitt (14/8/14)
Eurozone growth splutters to a halt as crisis enters new phase The Guardian, Larry Elliott (14/8/14)
Eurozone can learn from George Osborne and Bank of England stimulus The Guardian, Larry Elliott (14/8/14)
Broken Europe: economic growth grinds to a standstill The Telegraph, Szu Ping Chan (14/8/14)
One-in-three chance the ECB conducts quantitative easing next year – Reuters Poll Reuters, Sumanta Dey (13/8/14)
Eurozone’s Unravelling Recovery: What’s Going Wrong Across Troubled Currency Bloc International Business Times, Finbarr Bermingham (14/8/14)
France calls on ECB to act as eurozone growth grinds to a halt The Guardian, Larry Elliott (14/8/14)
That sinking feeling (again) The Economist (30/8/14)
Data
GDP stable in the euro area and up by 0.2% in the EU28 eurostat euroindicators (14/8/14)
Statistics Pocket Book ECB
European Economy: links to data sources Economics Network
Euro area economic and financial data ECB
Questions
- Explain how quantitative easing works.
- Why has the ECB been reluctant to introduce QE?
- What is meant by sterilisation? Why did the ECB sterilise the effects of the assets purchased under the Securities Markets Programme? Why did it cease doing this in June?
- How have events in Ukraine and political reactions to them influenced the eurozone economy?
- Should QE be ‘fast tracked’? Would there be any dangers in this?
- What is the ‘Funding for Lending’ scheme in the UK? Is the planned introduction of TLTROs similar to Funding for Lending?
The IMF has just published its 6-monthly World Economic Outlook report. The report is moderately optimistic, arguing that ‘global activity has broadly strengthened and is expected to improve further in 2014–15’. World growth is expected to rise from 3.0% in 2013 to 3.6% in 2014 and 3.9% in 2015,
Much of the impetus for an acceleration in growth is expected to come from advanced countries. Growth in these countries is expected to average 2¼% in 2014–15, a rise of 1 percentage point compared with 2013. Part of the reason is that these countries still have large output gaps and thus have considerable scope to respond to rises in aggregate demand.
Monetary policy in advanced countries remains accommodative, although the USA has begun to taper off its quantitative easing programme. It is possible, however, that the ECB may make its monetary policy more accommodative, with signs that it might embark on quantitative easing if eurozone growth remains weak and if the risks of deflation rise. If the average price level in the eurozone does fall, this could dampen demand as consumers defer consumption until prices have fallen.
As far as emerging economies are concerned, growth is projected to ‘pick up gradually from 4.7 percent in 2013 to about 5 percent in 2014 and 5¼% in 2015’. Although predicted growth is higher in emerging countries than in advanced countries, its acceleration is less, and much of the predicted growth is dependent on rising export sales to the advanced countries.
Global growth, however, is still fragile. Emerging market economies are vulnerable to a slowing or even reversal of monetary flows from the USA as its quantitative easing programme winds down. Advanced countries are vulnerable to deflationary risks. ‘The result [of deflation] would be higher real interest rates, an increase in private and public debt burdens, and weaker demand and output.’
The UK is predicted to have the strongest growth (2.9%) of the G7 countries in 2014 (see above chart). But the IMF cautions about being too optimistic:
Growth has rebounded more strongly than anticipated in the United Kingdom on easier credit conditions and increased confidence. However, the recovery has been unbalanced, with business investment and exports still disappointing.
Articles
IMF: World economy stronger; recovery uneven USA Today, Paul Davidson (8/4/14)
Emerging markets feel the pressure The Telegraph, Szu Ping Chan (8/4/14)
IMF cuts downturn danger to near zero Financial Times, Chris Giles (8/4/14)
IMF warns eurozone and ECB on deflation threat RTE News (8/4/14)
Recovery strong but risk shifts to emerging markets: IMF CNBC, Kiran Moodley (8/4/14)
IMF: World economy is stronger but faces threats Bloomberg Businessweek, Christopher S. Rugaber (8/4/14)
IMF: UK economic growth to reach 2.9% in 2014 BBC News (8/4/14)
IMF: UK economic growth to reach 2.9% in 2014 BBC News, Hugh Pym (8/4/14)
Five signs that the global economic recovery may be an illusion The Guardian, Larry Elliott (6/4/14)
Report and data
World Economic Outlook (WEO) International Monetary Fund (8/4/14)
World Economic Outlook Database IMF (8/4/14)
Questions
- Why does the IMF expect the world economy to grow more strongly in 2014 and 2015 than in 2013?
- What are the greatest risks to economic growth for (a) advanced countries; (b) developing countries?
- What geo-political events could negatively affect economic growth in (a) the eurozone; (b) the global economy?
- In what ways is the UK’s economic growth unbalanced?
- How much credence should be given to economic forecasts?
- Should countries’ economic performance be judged primarily by their growth in GDP?
The growth of China over the past decade has been quite phenomenal, with figures recorded in double-digits. However, in the aftermath of the recession, growth has declined to around 7% – much higher than Western economies are used to, but significantly below the ‘norm’ for China. (Click here for a PowerPoint of the chart.)
The growth target for this year is 7.5%, but there appear to be some concerns about China’s ability to reach this figure and this has been emphasised by a recent Chinese policy.
A mini-stimulus package has been put in place, with the objective of meeting the 7.5% growth target. Government expenditure is a key component of aggregate demand and when other components of AD are lower than expected, boosting ‘G’ can be a solution. However, it’s not something that the Chinese government has had to do in recent years and the fact that this stimulus package has been put in place has brought doubts over China’s economic performance to the forefront , but has confirmed its commitment to growth. Mizuho economist, Shen Jianguang, said:
It’s very obvious that the leaders feel the need to stabilise growth…Overall, the 7.5 per cent growth target means that the government still cares a lot about economic growth.
Data suggest that growth in China is relatively weak and there are concerns that the growth target will be missed, hence the stimulus package. In the aftermath of the 2008 financial crisis, there was a large stimulus package in place in China. This latest investment by the government is in no way comparable to the size of the 2008 package, but instead will be on a smaller and more specific scale. Mark Williams of Capital Economics said:
It’s a bit of a rerun of what we saw last year – something less than a stimulus package and more of piecemeal measures to ensure they reach their growth target.
It is the construction of public housing and railways that will be the main areas of investment this time round. A sum of $120–180bn per year will be available for railway construction and $161bn for social housing, and tax breaks are being extended for small businesses.
The 2008 stimulus package saw debt increase to some 200% of GDP, which did cause growing concerns about the reliance on debt. However, this latest package will be financed through the issue of bonds, which is much more similar to how market economies finance spending.
The fact that the government has had to intervene with such a stimulus package is, however, causing growing concerns about the level of debt and the future of this fast growing economy, though the new method of financing is certainly seen as progress.
It should be noted that a decline in growth for China is not only concerning for China itself, but is also likely to have adverse consequences other countries. In the increasingly interdependent world that we live in, Western countries rely on foreign consumers purchasing their exports, and in recent years it has been Chinese consumers that have been a key component of demand. However, a decline in growth may also create some benefits – resources may not be used up as quickly and prices of raw materials and oil in particular may remain lower.
It is certainly too early for alarm bells, but the future of China’s growth is less certain than it was a decade ago. The following articles consider this issue.
China’s new mini-stimulus offers signs of worry and progress BBC News, Linda Yueh (3/4/14)
China puts railways and houses at hear of new stimulus measures The Guardian (3/4/14)
China unveils mini stimulus to to boost slowing economy The Telegraph (3/4/14)
China stimulus puts new focus on growth target Wall Street Journal, Bob Davis and Michael Arnold (3/4/14)
China embarks on ‘mini’ stimulus programme to kick-start economy Independent, Russell Lynch (3/4/14)
China takes first step to steady economic growth Reuters (2/4/14)
China unveils fresh stimulus The Autstralian (3/4/14)
China’s reformers can triumph again, if they follow the right route The Guardian, Joseph Stiglitz (2/4/14)
Questions
- How has Chinese growth reached double-digits? Which factors are responsible for such high growth?
- The BBC News article suggests that the stimulus package is cause for concerns but also shows progress. How can it do both?
- Using a diagram, illustrate how a stimulus package can boost economic growth.
- What are the advantages and disadvantages of high rates of growth for (a) China and (b) Western economies?
- Why does the method of financing growth matter?
- Railway and housing construction have been targeted to receive additional finance. Why do you think these sectors have been targeted?
Globalisation has led to an increasingly interdependent world, with companies based in one country often dependent on a market abroad. In recent years, it is the rapid growth of countries like China that has led to growth in the size of the markets for many products. With incomes rising in emerging countries, demand for many products has been growing, but in the past year, the trend for Prada has ended and seems to be reversing.
As the market in China matures and growth of demand in Europe slows, Prada has seen its shares fall by the largest margin since June last year.
Prada is a well-known luxury brand. The products it sells are relatively expensive and hence its products are likely to have an income elasticity of demand well above +1. With changes in China and Europe, Prada expects its growth in sales to January 2015 will be ‘low single-digit’ – less than the 7% figure recorded for the last financial year.
This lower growth in same-store sales is likely to continue the following year as well. Add on to this the lower-than-expected profits, which missed analysts’ forecasts, and you have a prime example of a brand that is suffering because of its customer base and the economic times.
Prada isn’t alone in suffering from economic conditions and, relative to its European counterparts, is expected to have higher growth in sales and profits in the next 12 months – at 11.5% and 14.8% respectively. This is according to a survey by Thomson Reuters.
Prada has exploited high demand by Chinese consumers, but has recently been affected by the strength of the euro. A strong euro means that the Italian-based Prada is struggling with exports, which only adds to its problems. As economic growth picks up in China and as other emerging economies begin to experience more rapid economic growth, the fortunes of this luxury-retailer may change once more. However, with volatile economic times still around in many countries, the future of many retailers selling high-end products to higher income customers will remain uncertain. The following articles consider the fortunes of Prada.
Prada shares fall sharply after China luxury warning BBC News (3/4/14)
Prada falls after forecasting slowing luxury sales growth Bloomberg, Andrew Roberts and Vinicy Chan (3/4/14)
Prada profits squeezed by weakness in Europe and crackdown in China The Guardian (2/4/14)
Prada bets on men to accelerate sales growth Reuters, Isla Binnie (2/4/14)
Prada misses full year profit forecast Independent, Laura Chesters (2/4/14)
Questions
- How can we define a luxury product?
- Explain the main factors which have led to a decline in the demand for Prada products over the past 12 months.
- Using a diagram, illustrate what is meant by a strong euro and how this affects export demand.
- What business strategies are Prada expected to adopt to reverse their fortunes?
- Using a diagram, explain the factors that have caused Prada share prices to decline.
The latest balance of payments data for the UK show that in the final two quarters of 2013 the current account deficit as a percentage of GDP was the highest ever recorded. In quarter 3 it was 5.6% of GDP and in quarter 4 it was 5.4% of GDP. The previous highest quarterly figures were 5.3% in 1988 Q4 and 5.2% in 1989 Q3. The average current account deficit from 1960 to 2013 has been 1.1% of GDP and from 1980 to 2013 has been 1.6% of GDP.
The current account has four major components: the balance on goods, the balance on services, the balance on current transfers and the balance on income flows (e.g. investment income). The chart below shows the annual balances of each of these components, plus the overall current account balance, from 1960 to 2013.
There are large differences in the balances of these four and the differences seem to be widening. (Click here for a PowerPoint of the chart.)
Traditionally the balance on goods has been negative. In 2013 Q3 the deficit on goods reached a record 7.3% of GDP. It fell back somewhat in Q4 to 6.5%, still significantly above the average since 2000 of 5.5%. With the economy still recovering slowly, it would normally be expected that the trade deficit would be low. However, the high exchange rate has made it difficult for UK exporters to compete. Also with consumer confidence returning, imports are rising, again boosted by the high exchange rate, which makes imports cheaper.
The services balance, by contrast, is typically in surplus. In the final two quarters of 2013, the surpluses were 4.9% and 5.1% of GDP respectively. These compare with an average of 3.3% since 2000. It seems that the service sector, which includes banking, insurance, consultancy, advertising, accountancy, law, etc., is much more able to compete in a global environment.
The balance of current transfers to and from such bodies as the EU and UN have traditionally been negative, although as a proportion of GDP this has gradually widened in recent years. In 2013 the deficit was 1.7% compared with an average of 1.0% since 2000.
The most dramatic change has been in income flows and particularly those from investment. Before the crash in late 2008, the returns to many of the risky investments abroad made by UK financial institutions were very high. Income flows in the 12 months 2007 Q4 to 2008 Q3 averaged a surplus of 2.8% of GDP. They stayed positive, albeit at lower levels, until 2012 Q1, but then became negative as UK institutions reduced their exposure to overseas investments and as earnings in the UK by overseas investors increased. In the last two quarters of 2013, the deficits on income flows were 1.4% and 2.5% of GDP respectively.
How do these figures accord with the Chancellor’s desire to rebalance the economy towards exports? In terms of services, the export performance is good. In terms of goods, however, exports actually fell in the last two quarters from £78.4bn to £74.8bn. Although imports fell too in the final quarter, there is a danger that, with recovery and a high pound, these could begin to rise rapidly
So should the Bank of England attempt to bring the sterling exchange rate down? After all, the exchange rate index has risen from 79.1 in March 2013 to 85.9 in February 2014 (an appreciation of 8.6%). But if it did want to do so, what could it do? The traditional methods of reducing Bank rate and increasing the money supply are not open to it at the present time: Bank rate, at 0.5%, is already about as low as it could go and the Bank has ruled out any further quantitative easing.
The articles consider the latest balance of payments figures and their implications for the economy and for economic policy
Articles
UK current account deficit far bigger than forecast The Guardian, Katie Allen (28/3/14)
UK current account deficit near record high at £22.4bn BBC News (28/3/14)
UK current account gap second widest on record The Telegraph, Szu Ping Chan (28/3/14)
When will the UK pay its way? BBC News, Robert Peston (28/3/14)
Current account deficit crisis creeping up on UK can no longer be ignored The Guardian, Larry Elliott (30/3/14)
Data
Balance of Payments, Q4 and annual 2013 ONS (28/3/14)
Statistical Interactive Database – interest & exchange rates data Bank of England
Questions
- If the current account is in deficit, how is the overall balance of payments in balance (i.e. is in neither deficit nor surplus)?
- If the current account is in record deficit, why has sterling appreciated over recent months? What effect is this appreciation likely to have on the balance on trade in goods and services?
- Why has the balance on investment income deteriorated? In what ways could this be seen as a ‘good thing’?
- To what extent do the balance of payments figures show a rebalancing of the economy in the way the Chancellor would like?
- What could the Bank of England do to bring about a depreciation of sterling?
- What would be the benefits and costs of a depreciation of sterling?
- Why do investors overseas seem so willing to lend to the UK, thereby producing a large surplus on the financial account?
The eurozone recorded 0.0% growth in the second quarter of 2014. While the UK and USA are now experiencing relatively buoyant economic growth, the eurozone as a whole is stagnating. Some of the 18 eurozone countries, it is true, are now growing, including Spain, Portugal, Ireland and the Netherlands. But the German and Italian economies contracted in the three months to the end of June, while France experienced zero growth.
