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 linked article below from The Guardian paints a disturbing picture of the long-term problem of servicing both private-sector and public-sector debts.
With interest rates at historical lows, the problem has been masked for the time being. But with interest rates set to rise within a few months, and significantly over the coming years, the burden of debt servicing is likely to become severe. This could have profound effects both on long-term economic growth and on the distribution of income.
As the author, Phillip Inman states:
The funding gap is growing and with deficits on so many fronts, it is hard to see how promises to pensioners and health service users can be met without a dash for growth that is unsustainable, a switch to dramatic cost-cutting in other areas or higher taxes on those who came through the recession relatively unscathed.
You are probably facing the problem of growing debt yourself. How long, if ever, will it take you to repay your student loans? What impact will this have on your ability to spend and to have a ‘decent’ standard of living? Will you be able to afford a mortgage large enough to buy a reasonable house or flat? Will you be able to afford to do a masters degree or PhD without support from your parents or relatives or without a scholarship? And even if you manage to secure a well-paid job, will you be able to afford a reasonable pension for when you eventually retire?
The article looks at the nature of the problem and its causes. It concludes by saying:
Britain has become expert at putting off decisions and hoping for something to turn up. Without a return to ultra-cheap commodities, another technological/productivity revolution, or a return to more modest living and delayed gratification, it’s a plan that is running out of time.
Article
Trouble in store: the grave future of British public and private debt The Guardian, Phillip Inman (20/7/14)
Report
Fiscal sustainability report Office for Budget Responsibility (10/7/14)
Fiscal sustainability report – Executive summary Office for Budget Responsibility (10/7/14)
Fiscal sustainability report – Supplementary data series Office for Budget Responsibility (10/7/14)
Questions
- Why is public-sector debt likely to continue rising significantly over the coming years unless there is a concerted policy to make cuts in public expenditure?
- What factors are likely to lead to a rise in private-sector debt over the coming years?
- What factors have caused a redistribution from the younger to the older generation?
- How have ultra low interest rates affected the distribution of income?
- What is likely to happen to the gap in wages between ‘graduate’ jobs and ‘non-graduate’ jobs? Identify the factors likely to influence this gap?
- What is meant by ‘hire purchase’? Are leasing schemes for car purchase a form of ‘hire purchase? Are there similar schemes in the housing market?
- Does it matter if a country’s debts rise (either public or private) if the creditors are in the same country? Explain.
House prices have been rising strongly in London. According to the Halifax House Price index, house prices in London in the first quarter of 2014 were 15.5% higher than a year ago. This compares with 8.7% for the UK as a whole, 1.3% for the North of England and –1.5% for Scotland. CPI inflation was just 1.6% for the same 12-month period.
The London housing market has been stoked by rising incomes in the capital, by speculation that house prices will rise further and by easy access to mortgages, fuelled by the government’s Help to Buy scheme, which allows people to put down a deposit of as little as 5%. House prices in London in the first quarter of 2014 were 5.3 times the average income of new mortgage holders, up from 3.5 times in the last quarter of 2007, just before the financial crisis.
Concerns have been growing about increasing levels of indebtedness, which could leave people in severe financial difficulties if interest rates were to rise significantly. There are also concerns that an increasing proportion of people are being priced out of the housing market and are being forced to remain in the rental sector, where rents are also rising strongly.
But how can the housing market in London be dampened without dampening the housing market in other parts of the country where prices are barely rising, and without putting a break on the still relatively fragile recovery in the economy generally?
The Governor of the Bank of England has just announced two new measures specific to the housing market and which would apply particularly in London.
The first is to require banks to impose stricter affordability tests to new borrowers. Customers should be able demonstrate their ability to continue making their mortgage payments if interest rates were 3 percentage points higher than now.
The second is that mortgage lenders should restrict their lending to 4½ times people’s income for at least 85% of their lending.
Critics are claiming that these measures are likely to be insufficient. Indeed, Vince Cable, the Business Secretary, has argued for a limit of 3½ times people’s income. Also banks are already typically applying a ‘stress test’ that requires people to be able to afford mortgage payments if interest rates rose to 7% (not dissimilar to the Bank of England’s new affordability test).
The videos and articles look at the measures and consider their adequacy in dealing with what is becoming for many living in London a serious problem of being able to afford a place to live. They also look at other measures that could have been taken.
Webcasts and Podcasts
The Bank of England announces plans for a new affordability test BBC News (26/6/14)
Bank of England moves to avert housing boom BBC News, Simon Jack (26/6/14)
Bank of England to act on house prices in south-east BBC News, Robert Peston (25/6/14)
Bank of England measures ‘insure against housing boom’ BBC News, Robert Peston (26/6/14)
Carney: There is a ‘new normal’ for interest rates BBC Today Programme, Mark Carney (27/6/14)
Articles
Bank of England imposes first limits on size of UK mortgages Reuters, Ana Nicolaci da Costa and Huw Jones (26/6/14)
Stability Report – Mark Carney caps mortgages to cool housing market: as it happened June 26, 2014 The Telegraph, Martin Strydom (26/6/14)
Bank of England cracks down on mortgages The Telegraph, Szu Ping Chan (26/6/14)
Mortgage cap ‘insures against housing boom’ BBC News (26/6/14)
Viewpoints: Is the UK housing market broken? BBC News (26/6/14)
How can UK regulators cool house prices? Reuters (25/6/14)
Bank will not act on house prices yet, says Carney The Guardian, Jill Treanor and Larry Elliott (26/6/14)
Mark Carney’s housing pill needs time to let economy digest it The Guardian, Larry Elliott (26/6/14)
Bank Of England Admits Plans To Cool Housing Market Will Have ‘Minimal’ Impact Huffington Post, Asa Bennett (26/6/14)
Carney Surprises Are Confounding Markets as U.K. Central Bank Manages Guidance Bloomberg, Scott Hamilton and Emma Charlton (26/6/14)
House prices: stop meddling, Mark Carney, and bite the bullet on interest rates The Telegraph, Jeremy Warner (27/6/14)
Mark Carney’s Central Bank Mission Creep Bloomberg, Mark Gilbert (26/6/14)
Consultation paper
Implementing the Financial Policy Committee’s Recommendation on loan to income ratios in mortgage lending Bank of England (26/6/14)
Bank of England consults on implementation of loan-to-income ratio limit for mortgage lending Bank of England News Release (26/6/14)
Data
Links to sites with data on UK house prices Economic Data freely available online, The Economics Network
Questions
- Identify the main factors on the demand and supply sides that could cause a rise in the price of houses. How does the price elasticity of demand and supply affect the magnitude of the rise?
- What other measures could have been taken by the Bank of England? What effect would they have had on the economy generally?
- What suggests that the Bank of England is not worried about the current situation but rather is taking the measures as insurance against greater-than-anticipated house price inflation in the future?
- Why are UK households currently in a ‘vulnerable position’?
- What factors are likely to determine the future trend of house prices in London?
- Is house price inflation in London likely to stay significantly above that in other parts of the UK, or is the difference likely to narrow or even disappear?
- Should the Bank of England be given the benefit of the doubt in being rather cautious in its approach to dampening the London housing market?
The spectre of deflation haunts the eurozone economy. Inflation in the 12 months to May 2014 was 0.5%, down from 0.7% to April and well below the target of 2% (see). Price deflation can result in deflation of the whole economy. With the prospect of falling prices, many consumers put off spending, hoping to buy things later at a lower price. This delay in spending deflates aggregate demand and can result in a decline in growth or even negative growth: hardly a welcome prospect as the eurozone still struggles to recover from the long period of recession or sluggish growth that followed the 2007–8 financial crisis.
The ECB is well aware of the problem. Its President, Mario Draghi, has stated on several occasions that the central bank will do whatever it takes to ward off deflation and stimulate recovery. At its monthly meeting on 5 June, the ECB Council acted. It took the following measures (see Mario Draghi’s press conference and the press release):
• The main refinancing rate it charges banks on reverse repos (when using open-market operations) was cut from 0.25% to 0.15%.
• The rate it pays banks for depositing money in the ECB was cut from 0% to –0.1%. In other words, banks would be charged for ‘parking’ money with the ECB rather than lending it.
• It will provide targeted lending to banks (targeted longer-term refinancing operations (TLTROs)), initially of 7% of the total amount of each banks’ loans to the non-financial private sector within the eurozone. This will be provided in two equal amounts, in September and December 2014. These extra loans will be for bank lending to businesses and households (other than for house purchase). The total amount will be some €400 billion. Substantial additional lending will be made available quarterly from March 2016 to June 2016.
• It will make preparations for an asset purchase scheme. Unlike that in the UK, which involves the purchase of government bonds, this will involve the purchase of assets which involve claims on private-sector (non-financial) institutions. Depending on financing arrangements, this could amount to quantitative easing.
• It will suspend sterilising the extra liquidity that has been injected under the Securities Markets Programme (operated from May 2010 to September 2012), which involved purchasing eurozone countries’ existing bonds on the secondary market. In other words it will stop preventing the securities that have been purchased from increasing money supply. This therefore, for the first time, represents a genuine form of quantitative easing.
The question is whether the measures will be enough to stimulate the eurozone economy, prevent deflation and bring inflation back to around 2%. The measures are potentially significant, especially the prospect of quantitative easing – a policy pursued by other main central banks, such as the Fed, the Bank of England and the Bank of Japan. A lot depends on what the ECB does over the coming months.
The following articles consider the ECB’s policy. The first ones were published before the announcement and look at alternatives open to the ECB. The others look at the actual decisions and assess how successful they are likely to be.
Articles published before the announcement
Mario Draghi faces moment of truth as man with power to steady eurozone The Observer, Larry Elliott (1/6/14)
What the ECB will do in June? Draghi spells it out The Economist (26/5/14)
Draghi as Committed as a Central Banker Gets, as Economists Await ECB Stimulus Bloomberg, Alessandro Speciale and Andre Tartar (19/5/14)
ECB’s credit and credibility test BBC News, Robert Peston (2/6/14)
90 ECB decamps to debate monetary fixes Financial Times, Claire Jones (25/5/14)
Speech
Monetary policy in a prolonged period of low inflation ECB, Mario Draghi (26/5/14)
Articles published after the announcement
ECB launches €400bn scheme, seeks to force bank lending Irish Independent (5/6/14)
The ECB’s toolbox BBC News, Linda Yueh (5/6/14)
ECB’s justified action will help but is no panacea for eurozone deflationary ills The Guardian, Larry Elliott (5/6/14)
Why Negative Rates Won’t Work In The Eurozone Forbes, Frances Coppola (4/6/14)
Germany’s fear of QE is what’s stopping us from cracking open the Cava The Telegraph, Roger Bootle (8/6/14)
Data
Euro area economic and financial data ECB
Questions
- Why has the eurozone experienced falling inflation and a growing prospect of negative inflation?
- Explain how the Securities Markets Programme (SMP) worked (check it out on the ECB site). What countries’ bonds were purchased and why?
- What is meant by sterilisation? Why did the ECB sterilise the effects of the assets purchased under the SMP?
- If it is practical for the ECB to set a negative interest rate on the deposit facility for banks, would it be practical to set a negative interest rate for the main refinancing operations or the marginal lending facility? Explain.
- Why has the ECB, up to now, been unwilling to engage in quantitative easing? What has changed?
- Why may the introduction of a negative interest rate on bank deposits in the ECB have only a very small effect on bank lending?
- How much is broad money supply growing in the eurozone? Is this enough or too much? Explain.
- What else could the ECB have done to ward off deflation? Should the ECB have adopted these measures?
At the end of January 2014, we looked at the problem of deflation and in particular at the fortunes of Japan, as its CPI was rising. As the blog explained, the Japanese economy, rather than being plagued by high inflation has been plagued by deflation and many suggest this is even worse.
In December 2013, Japan’s core consumer prices were growing faster than expected. The data gave the economy a much needed boost, following increases in government spending aimed at stimulating aggregate demand. This in turn pushed up prices, such that they achieved their fastest rate of growth in 5 years. Now, more recent date from May 2014 shows that the trend has continued. Prices in Japan have now increase at their fastest rate in 23 years, rising 3.2% and beating the forecasts of 3.1%. This means that prices have no risen in Japan for 11 consecutive months. Numerous policies have contributed towards this impressive trend for an economy plagued by deflation for 2 decades. Boosts in the money supply, increases in government spending, a rise in sales tax are just some of the contributing factors.
Although the economy is certainly over the problem of deflation, some are now concerned that such price rises may reduce consumer spending. An ironic twist, given that barely a year ago the concern about low consumer spending was due to deflation. The next 12 months will be a key indicator of how consumers will respond to this unusual inflation data – after all inflation and high prices have been pretty uncommon. The following articles consider the update on the Japanese economy.
Japan inflation rate hits 23 year high (including video) BBC News (30/5/14)
Japan April core CPI rises to 23-year high after sales tax rise Reuters (29/5/14)
Japan inflation accelerates Wall Street Journal, Takashi Nakamichi (30/5/14)
Japan’s consumer inflation set to reach five year high The Guardian (18/4/14)
Japan’s inflation at highest rate for 23 years The Telegraph, Rebecca Clancy (30/5/14)
Japan inflation quickens to fastest since 1991 Bloomberg, Toru Fujioka (30/5/14)
Japaense inflation rises at fastest pace in over five years at 1.3% in December 2013 Independent, Russel Lynch (31/1/14)
Questions
- Why is deflation a problem?
- Using an AD/AS diagram, illustrate the problem of expectations and how this contributes to stagnant growth.
- Japanese policies have helped create a rise in the CPI. Which policies have been effective in creating rising prices?
- Explain how the sales tax has contributed towards higher prices.
- With prices rising, there are now concerned that consumer spending may decline. Using a diagram, explain why this may be the case.
- In the previous blog, we analysed the Indian economy and said that high inflation was something that was contributing towards lower growth. How is that low inflation or deflation can also contribute towards low growth?
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.
