With the UK and eurozone economies in recession and with business and consumer confidence low, the Bank of England and the ECB have sprung into action.
The ECB has cut its main refinancing rate from 1% to an all-time low of 0.75%. Meanwhile, the Bank of England has embarked on a further round of quantitative easing (QE). The MPC voted to inject a further £50 billion through its asset purchase scheme, bring the total to £375 billion since QE began in March 2009.
And it is not just in Europe that monetary policy is being eased. In Australia and China interest rates have been cut. In the USA, there have been further asset purchases by the Fed and it is expected that the Japanese central bank will cut rates very soon, along with those in Korea, Indonesia and Sri Lanka.
But with consumers seeming reluctant to spend and businesses being reluctant to invest, will the new money in the UK and elsewhere actually be lent and spent? Or will it simply sit in banks, boosting their liquidity base, but doing little if anything to boost aggregate demand?
And likewise in the eurozone, will a 25 basis point reduction in interest rates (i.e. a 0.25 percentage point reduction) do anything to boost borrowing and spending?
It is like pushing on a string – a term used by Keynesians to refer to the futile nature of monetary policy when people are reluctant to spend. Indeed the evidence over the past few years since QE started is that despite narrow money having risen massively, M4 lending has declined (see chart).
For a PowerPoint of the chart, click here.
The following articles look at the conundrum
Articles
Draghi-King Push May Mean Bigger Step Into Zero-Rate Era BloombergBusinessweek, Simon Kennedy (4/7/12)
QE and rate cut as central banks play stimulus card Independent, Ben Chu (6/7/12)
QE is welcome, but not enough Independent, Leader (6/7/12)
Interest rates cut to spur growth China Daily, Wang Xiaotian, Ding Qingfen and Gao Changxin (6/7/12)
Rate cuts shake global confidence Sydney Morning Herald, Eric Johnston, Clancy Yeates and Peter Cai (7/7/12)
Global Policy Easing Presses Asia to Cut Rates BloombergBusinessweek, Sharon Chen and Justina Lee (6/7/12)
Economic slowdown raises alarm in China, Europe Globe and Mail, Kevin Carmichael (5/7/12)
Bank of England sets sail with QE3 BBC News, Stephanie Flanders (5/7/12)
The twilight of the central banker The Economist (26/6/12)
The case for truly bold monetary policy Financial Times, Martin Wolf (28/6/12)
Questions
- Is the world economy in a liquidity trap?
- What advice would you give politicians around the world seeking to boost consumer and business confidence?
- Are we witnessing “The twilight of the central banker”? (See The Economist article above.)
- Explain the following extracts from the Martin Wolf article: “In a monetary system, based on fiat (or man-made) money, the state guarantees the money supply in the interests of the public. In normal times, however, actual supply is a byproduct of lending activities of banks. It is, in brief, the product of privately operated printing presses… In the last resort, the power to create money rests properly with the state. When private sector supply is diminishing, as now, the state not only can, but should, step in, with real urgency.”
- Should monetary policy in the UK be combined with fiscal policy in providing a stimulus at a time when the government can borrow ultra cheaply from the Bank of England? Does this apply to other governments around the world?
- Why did Asian share prices fall despite the stimulus?
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?
World leaders have been meeting in Rio de Janeiro at a United Nations Conference on Sustainable Development. The conference, dubbed ‘Rio+20’, refers back to the first UN Conference on Environment and Development (UNCED) held in Rio 20 years ago in June 1992.
The 1992 conference adopted an Agenda 21. It was “comprehensive plan of action to be taken globally, nationally and locally by organizations of the United Nations System, Governments, and Major Groups in every area in which human impacts on the environment.”
The 2012 conference has looked at progress, or lack of it, on sustainability and what needs to be done. It has focused on two major themes: “how to build a green economy to achieve sustainable development and lift people out of poverty, including support for developing countries that will allow them to find a green path for development; and how to improve international coordination for sustainable development.” Issues examined have included decent jobs, energy, sustainable cities, food security and sustainable agriculture, water, oceans and disaster readiness.
But just what is meant by sustainable development? The conference defines sustainable development as that which meets the needs of the present without compromising the ability of future generations to meet their own needs. “Seen as the guiding principle for long-term global development, sustainable development consists of three pillars: economic development, social development and environmental protection.”
The articles below look at prospects for national and global sustainability. They also look at a new measure of national wealth, the Inclusive Wealth Index (IWI). This index has been developed under the auspices of the International Human Dimensions Programme on Global Environmental Change (IHDP) and published in its Inclusive Wealth Report 2012 (see report links below).
The IWR 2012 was developed on the notion that current economic production indicators such as gross domestic product (GDP) and the Human Development Index (HDI) are insufficient, as they fail to reflect the state of natural resources or ecological conditions, and focus exclusively on the short term, without indicating whether national policies are sustainable.
The IWR 2012 features an index that measures the wealth of nations by looking into a country’s capital assets, including manufactured, human and natural capital, and its corresponding values: the Inclusive Wealth Index (IWI). Results show changes in inclusive wealth from 1990 to 2008, and include a long-term comparison to GDP for an initial group of 20 countries worldwide, which represent 72% of the world GDP and 56% of the global population. (Click on chart for a larger version.)
So will growth in IWI per capita be a better measure of sustainable development than growth in GDP per capita? The articles also consider this issue.
Articles: summit
Rio+20 deal weakens on energy and water pledges BBC News, Richard Black (17/6/12)
Rio+20: Progress on Earth issues ‘too slow’ – UN chief BBC News, Richard Black (20/6/12)
Rio+20 Earth Summit Q&A The Telegraph, Louise Gray (16/5/12)
Rio+20 Earth Summit: campaigners decry final document Guardian, Jonathan Watts and Liz Ford (23/6/12)
A catastrophe if global warming falls off the international agenda Observer, Will Hutton (24/6/12)
Analysis: Rio +20 – Epic Fail The Bureau of Investigative Journalism Brendan Montague (22/6/12)
Articles: IWI
Accounting for natural wealth gains world traction Atlanta Business NewsKaty Daigle (17/6/12) (see alternatively)
New index shows lower growth for major economies Reuters, Nina Chestney (17/6/12)
A New Balance Sheet for Nations: UNU-IHDP and UNEP Launch Sustainability Index that Looks Beyond GDP EcoSeed (20/6/12)
World’s leading economies lag behind in natural capital Firstpost (18/6/12)
Beyond GDP: Experts preview ‘Inclusive Wealth’ index at Planet under Pressure conference EurekAlert, Terry Collins (28/3/12)
New sustainability index created that looks at more than gross domestic product bits of science (17/6/12)
For Sustainability, Go Beyond Gross Domestic Product Scientific AmericanDavid Biello (17/6/12)
Report
Inclusive Wealth Report 2012: Overview IHDP
Inclusive Wealth Report 2012: Summary for Decision-makers IHDP
Inclusive Wealth Report 2012: full report IHDP
Questions
- What progress has been made towards sustainable development over the past 20 years?
- What are the limitations of conferences such as Rio+20 in trying to achieve global action?
- With the current challenges faced by the eurozone and the global economy more generally, is this a good time to be discussing long-term issues of sustainable development?
- Explain how IWI is derived and measured?
- Looking at the chart above, explain the very different positions of countries in the three columns.
- What are the strengths and weaknesses of using growth in IWI compared with using growth in GDP as measures of (a) economic development; (b) economic wellbeing?
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?
