Growth in the eurozone has slowed. The European Central Bank (ECB) now expects it to be 1.1% this year; in December, it had forecast a rate of 1.7% for 2019. Mario Draghi, president of the ECB, in his press conference, said that ‘the weakening in economic data points to a sizeable moderation in the pace of the economic expansion that will extend into the current year’. Faced with a slowing eurozone economy, the ECB has announced further measures to stimulate economic growth.
First it has indicated that interest rates will not rise until next year at the earliest ‘and in any case for as long as necessary to ensure the continued sustained convergence of inflation to levels that are below, but close to, 2% over the medium term’. The ECB currently expects HIPC inflation to be 1.2% in 2019. It was expected to raise interest rates later this year – probably by the end of the summer. The ECB’s main refinancing interest rate, at which it provides liquidity to banks, has been zero since March 2016, and so there was no scope for lowering it.
Second, although quantitative easing (the asset purchase programme) is coming to an end, there will be no ‘quantitative tightening’. Instead, the ECB will purchase additional assets to replace any assets that mature, thereby leaving the stock of assets held the same. This would continue ‘for an extended period of time past the date when we start raising the key ECB interest rates, and in any case for as long as necessary to maintain favourable liquidity conditions and an ample degree of monetary accommodation’.
Third, the ECB is launching a new series of ‘quarterly targeted longer-term refinancing operations (TLTRO-III), starting in September 2019 and ending in March 2021, each with a maturity of two years’. These are low-interest loans to banks in the eurozone for use for specific lending to businesses and households (other than for mortgages) at below-market rates. Banks will be able to borrow up to 30% of their eligible assets (yet to be fully defined). These, as their acronym suggests, are the third round of such loans. The second round was relatively successful. As the Barron’s article linked below states:
Banks boosted their long-term borrowing from the ECB by 70% over the course of the program, although they did not manage to increase their holdings of business loans until after TLTRO II had finished disbursing funds in March 2017.
Whether these measures will be enough to raise growth rates in the eurozone depends on a range of external factors affecting aggregate demand. Draghi identified three factors which could have a negative effect.
- Brexit. The forecasts assume an orderly Brexit in accordance with the withdrawal deal agreed between the European Commission and the UK government. With the House of Commons having rejected this deal twice, even though it has agreed that there should not be a ‘no-deal Brexit’, this might happen as it is the legal default position. This could have a negative effect on the eurozone economy (as well as a significant one on the UK economy). Even an extension of Article 50 could create uncertainty, which would also have a negative effect
- Trade wars. If President Trump persists with his protectionist policy, this will have a negative effect on growth in the eurozone and elsewhere.
- China. Chinese growth has slowed and this dampens global growth. What is more, China is a major trading partner of the eurozone countries and hence slowing Chinese growth impacts on the eurozone through the international trade multiplier. The ECB has taken this into account, but if Chinese growth slows more than anticipated, this will further push down eurozone growth.
Then there are internal uncertainties in the eurozone, such as the political and economic uncertainty in Italy, which in December 2018 entered a recession (2 quarters of negative economic growth). Its budget deficit is rising and this is creating conflict with the European Commission. Also, there are likely to be growing tensions within Italy as the government raises taxes.
Faced with these and other uncertainties, the measures announced by Mario Draghi may turn out not to be enough. Perhaps in a few months’ there may have to be a further round of quantitative easing.
Articles
- ECB statement following policy meeting
Reuters, Larry King (7/3/19)
- European Central Bank acts to boost struggling eurozone
BBC News, Andrew Walker (7/3/19)
- The European Central Bank Tries to Avoid Repeating Past Mistakes
Barron’s, Matthew C. Klein (8/3/19)
- ECB pushes back rate hike plans, announces fresh funding for banks
CNBC, Silvia Amaro (7/3/19)
- Why the ECB Followed the Fed’s Flip-Flopping
Bloomberg, Mohamed A. El-Erian (7/3/19)
- Central Banks Don’t Have the Answer and Markets Know It
Bloomberg, Robert Burgess (7/3/19)
- Missing out on monetary normalisation
OMFIF, David Marsh (12/4/19)
- The ECB is attempting to get ahead of event
Financial Times, The editorial board (8/3/19)
- Explainer: What is the fuss about European Central Bank TLTRO loans?
Reuters, Balazs Koranyi (4/3/19)
Videos
ECB publications
Questions
- Investigate the history of quantitative easing and its use by the Fed, the Bank of England and the ECB. What is the current position of the three central banks on ‘quantitative tightening’, whereby central banks sell some of the stock of assets they have purchased during the process of quantitative easing or not replace them when they mature?
- What are TLTROs and what use of them has been made by the ECB? Do they involve the creation of new money?
- What will determine the success of the proposed TLTRO III scheme?
- If the remit of central banks is to keep inflation on target, which in the ECB’s case means below 2% HIPC inflation but close to it over the medium term, why do people talk about central banks using monetary policy to revive a flagging economy?
- What is ‘forward guidance’ by central banks and what determines its affect on aggregate demand?
One of President Trump’s main policy slogans has been ‘America first’. As Trump sees it, a manifestation of a country’s economic strength is its current account balance. He would love the USA to have a current account surplus. As it is, it has the largest current account deficit in the world (in absolute terms) of $481 billion in 2016 or 2.6% of GDP. This compares with the UK’s $115bn or 4.4% of GDP. Germany, by contrast, had a surplus in 2016 of $294bn or 8.5% of GDP.
However, he looks at other countries’ current account surpluses suspiciously – they may be a sign, he suspects, of ‘unfair play’. Germany’s surplus of over $50bn with the USA is particularly in his sights. Back in January, as President-elect, he threatened to put a 35% tariff on imports of German cars.
In practice, Germany is governed by eurozone rules, which prevent it from subsidising exports. And it does not have its own currency to manipulate. What is more, it is relatively open to imports from the USA. The EU imposes an average tariff of just 3% on US imports and importers also have to add VAT (19% in the case of Germany) to make them comparably priced with goods produced within the EU.
So why does Germany have such a large current account surplus? The article below explores the question and dismisses the claim that it’s the result of currency manipulation or discrimination against imports. The article states that the reason for the German surplus is that:
… it saves more than it invests. The correspondence of savings minus investment with exports minus imports is not an economic theory; it’s an accounting identity. Germans collectively spend less than they produce, and the difference necessarily shows up as net exports.
But why do the Germans save so much? The answer given is that, with an aging population, Germans are sensibly saving now to support themselves in old age. If Germany were to reduce its current account surplus, this would entail either the government reducing its budget surplus, or people reducing the amount they save, or some combination of the two. This is because a current account surplus, which consists of exports and other incomes from abroad (X) minus imports and any other income flowing abroad (M), must equal the surplus of saving (S) plus taxation (T) over investment (I) plus government expenditure (G). In terms of withdrawals and injections, given that:
I + G + X = S + T + M
then, rearranging the terms,
X – M = (S + T) – (I + G).
If German people are reluctant to reduce the amount they save, then an alternative is for the German government to reduce taxation or increase government expenditure. In the run-up to the forthcoming election on 24 September, Chancellor Merkel’s centre-right CDU party advocates cutting taxes, while the main opposition party, the SPD, advocates increasing government expenditure, especially on infrastructure. The article considers the arguments for these two approaches.
Article
The German economy is unbalanced – but Trump has the wrong answer The Guardian, Barry Eichengreen (12/5/17)
Data
German economic data (in English) Statistisches Bundesamt (Federal Statistical Office)
World Economic Outlook Databases IMF
Questions
- Why does Germany have such a large current account surplus?
- What are the costs and benefits to Germany of having a large current account surplus?
- What is meant by ‘mercantilism’? Why is its justification fallacious?
- If Germany had its own currency, would it be a good idea for it to let that currency appreciate?
- What are meant by ‘resource crowding out’ and ‘financial crowding out’? Why might the policies of tax cuts advocated by the CDU result in crowding out? What form would it take and why?
- Compare the relative benefits of the policies advocated by the CDU and SPD to reduce Germany’s budget surplus.
- Would other countries, such as the USA, benefit from a reduction in Germany’s current account surplus?
- Is what ways would the USA gain and lose from restricting imports from Germany? Would it be a net gain or loss? Explain.
Project Syndicate is an organisation which produces articles on a range of economic, political and social topics written by eminent scholars, political and business leaders, policymakers and civic activists. It then makes these available to news media in more than 150 countries. Here we look at four such articles which assess the outlook for the European and global economies and even that of capitalism itself.
The general tone is one of pessimism. Despite unconventional monetary policies, such as quantitative easing (QE) and negative nominal interest rates, the global recovery is anaemic. As the Nouriel Roubini articles states:
Unconventional monetary policies – entrenched now for almost a decade – have themselves become conventional. And, in view of persistent lacklustre growth and deflation risk in most advanced economies, monetary policymakers will have to continue their lonely fight with a new set of ‘unconventional unconventional’ monetary policies.
Perhaps this will involve supplying additional money directly to consumers and/or business in a so-called ‘helicopter drop’ of money. Perhaps it will be supplying money directly to governments to finance infrastructure projects – a policy dubbed ‘people’s quantitative easing‘. Perhaps it will involve taxing the holding of cash by banks to encourage them to lend.
The Hans-Werner Sinn article looks at some of the consequences of the huge amount of money created through QE and continuing to be created in the eurozone. Although it has not boosted consumption and investment nearly as much as desired, it has caused bubbles in various asset markets. For example, the property market has soared in many countries:
Property markets in Austria, Germany, and Luxembourg have practically exploded throughout the crisis, as a result of banks chasing borrowers with offers of loans at near-zero interest rates, regardless of their creditworthiness.
The German property boom could be reined in with an appropriate jump in interest rates. But, given the ECB’s apparent determination to head in the opposite direction, the bubble will only grow. If it bursts, the effects could be dire for the euro.
The Jean Pisani-Ferry article widens the analysis of the eurozone’s problems. Like Roubini, he considers the possibility of a helicopter drop of money, which “would be functionally equivalent to a direct government transfer to households, financed by central banks’ permanent issuance of money”.
Without such drastic measures he sees consumer and business pessimism (see chart) undermining recovery and making the eurozone vulnerable to global shocks, such as further weakening in China. (Click here for a PowerPoint of the chart.)
Finally, Anatole Kaletsky takes a broad historical view. He starts by saying that “All over the world today, there is a sense of the end of an era, a deep foreboding about the disintegration of previously stable societies.” He argues that the era of ‘leaving things to the market’ is coming to an end. This was an era inspired by the monetarist and supply-side revolutions of the 1960s and 1970s that led to the privatisation and deregulation policies of Reagan, Thatcher and other world leaders.
But if the market cannot cope with the complexities of today’s world, neither can governments.
If the world is too complex and unpredictable for either markets or governments to achieve social objectives, then new systems of checks and balances must be designed so that political decision-making can constrain economic incentives and vice versa. If the world is characterized by ambiguity and unpredictability, then the economic theories of the pre-crisis period – rational expectations, efficient markets, and the neutrality of money – must be revised.
… It is obvious that new technology and the integration of billions of additional workers into global markets have created opportunities that should mean greater prosperity in the decades ahead than before the crisis. Yet ‘responsible’ politicians everywhere warn citizens about a ‘new normal’ of stagnant growth. No wonder voters are up in arms.
His solution has much in common with that of Roubini and Pisani-Ferry. “Money could be printed and distributed directly to citizens. Minimum wages could be raised to reduce inequality. Governments could invest much more in infrastructure and innovation at zero cost. Bank regulation could encourage lending, instead of restricting it.”
So will there be a new era of even more unconventional monetary policy and greater regulation that encourages rather than restricts investment? Read the articles and try answering the questions.
Articles
Unconventional Monetary Policy on Stilts Project Syndicate, Nouriel Roubini (1/4/16)
Europe’s Emerging Bubbles Project Syndicate, Hans-Werner Sinn (28/3/16)
Preparing for Europe’s Next Recession Project Syndicate, Jean Pisani-Ferry (31/3/16)
When Things Fall Apart Project Syndicate, Anatole Kaletsky (31/3/16)
Questions
- Explain how a ‘helicopter drop’ of money would work in practice.
- Why has growth in the eurozone been so anaemic since the recession of 2009/10?
- What is the relationship between tightening the regulations about capital and liquidity requirements of banks and bank lending?
- Explain the policies of the different eras identified by Anatole Kaletsky.
- Would it be fair to describe the proposals for more unconventional monetary policies as ‘Keynesian’?
- If quantitative easing was used to finance government infrastructure investment, what would be the effect on the public-sector deficit and debt?
- If the inflation of asset prices is a bubble, what could cause the bubble to burst and what would be the effect on the wider economy?
The Federal Reserve chair, Janet Yellen, has been giving strong signals recently that the US central bank will probably raise interest rates at its December 16 meeting or, if not then, early in 2016. ‘Ongoing gains in the labor market’ she said, ‘coupled with my judgement that longer-term inflation expectations remain reasonably well anchored, serve to bolster my confidence in a return of inflation to 2%.’ This, as for many other central banks, is the target rate of inflation.
In anticipation of a rise in US interest rates, the dollar has been appreciating. Its (nominal) exchange rate index has risen by 24% since April 2014 (see chart below).
In the light of the sluggish eurozone economy, the ECB president, Mario Draghi, has been taking a very different stance. He has indicated that he stands ready to cut interest rates further and increase quantitative easing.
At the meeting on 3 December, the ECB did just that. It announced a further cut in the deposit rate, from –0.2 to –0.3 and an extension of the €60 billion per month QE programme from September 2016 to March 2017 (bringing the total by that time to €1.5 trillion – up from €1.1 trillion by September 2016).
Stock market investors had been expecting more, including an increase in the level of monthly asset purchases above €60 billion. Consequently stock markets fell. Both the German DAX and the French CAC 40 stock market indices fell by 3.6%. The euro also appreciated against the dollar by 2.7% on the day of the announcement. Nevertheless, since April 2014, the euro exchange rate index has fallen by 13%. Against the US dollar, the euro has depreciated by a massive 31%.
So what will be the consequences of the very different monetary policies being pursued by the Fed and the ECB? Are they simply the desirable responses to a lack of convergence of the economic performance of the US and eurozone economies? In other words, will they help to bring greater convergence between the two economies?
Or will the desirable effects of convergence be offset by other undesirable effects for the USA and the eurozone and also for the rest of the world?
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Will huge amounts of dollar-denominated debt held by many emerging economies make it harder to service these debts with an appreciating dollar? |
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How much will US exporters suffer from the dollar’s rise and what will the US authorities do about it? |
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Will currency volatility lead to currency wars and, if so, what will be their economic effects? |
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Will the time lags involved in the effects of the continuing programme of QE in the eurozone eventually lead to overheating? Already euro money supply is rising, on both narrow and broad measures. |
The following articles address these issues.
Articles
The Fed and the ECB: when monetary policy diverges The Guardian, Mohamed El-Erian (2/12/15)
European stocks slide after ECB dashes hopes of major QE expansion The Guardian, Heather Stewart and Graeme Wearden (3/12/15)
Mario Draghi riles Germany with QE overkill The Telegraph, Ambrose Evans-Pritchard (3/12/15)
How the eurozone missed its shot at a recovery The Telegraph, Peter Spence (3/12/15)
Yellen Signals Economy Nearly Ready for First Interest-Rate Hike Bloomberg, Christopher Condon (3/12/15)
Exchange rate data
Effective exchange rate indices Bank for International Settlements
Exchange rates Bank of England
Questions
- What would be the beneficial effects to the US and eurozone economies of their respective monetary policies?
- Explain the exchange rate movements that have taken place between the euro and the dollar over the past 19 months. How do these relate to the various parts of the balance of payments accounts of the two economies?
- Is it possible for the USA to halt the rise in the dollar while at the same time raising interest rates? Explain.
- Why are some members of the ECB (e.g. the German and Dutch) against expanding QE? Assess their arguments.
- What will be the impact of US and eurozone monetary policies on emerging economies?
- What will be the impact of US and eurozone monetary policies on the UK?
- Why did the euro appreciate after the Mario Draghi’s press statement on 3 December? What has happened to the dollar/euro exchange rate since and why?
The negotiations between Greece and the ‘troika’ of creditors (the IMF, the European Commission and the ECB) have seen many twists and turns before breaking down on 26 June. Throughout, both sides have sought to give as little as possible while seeking a compromise. Both sides have claimed that their position is reasonable, even though a gulf has remained between them.
What has been playing out is a high-stakes game, where the optimum outcome for each side is quite different.
Greece seeks bailout terms that would allow it to achieve a smaller primary budget surplus (but still a surplus in the midst of a deep recession). The surplus would be achieved largely through tax rises on the wealthy rather than further cuts that would hit the poor hard. It is also seeking a substantial amount of debt forgiveness to make servicing the remaining debt possible.
The troika is seeking a larger budget surplus than the Greeks are willing to contemplate. This, it maintains, should be achieved largely through additional cuts in government expenditure, including further reductions in pensions and in public-sector wages.
Both sides used threats and promises as the negotiations became more and more acrimonious.
The troika threatened to withhold the final €7.2bn of the bailout necessary to pay the €1.6bn due to the IMF on 30 June, unless the Greeks accepted the terms of the austerity package put to them. The Greek Prime Minister, Alexis Tsipras, in rejecting the proposals, called a referendum on the package. This threatens the stability of the eurozone as a No vote, if it led to a Greek exit from the eurozone, could undermine confidence in monetary union. After all, if Greece could be forced out, other countries facing severe difficulties might also be forced out at some point in the future. Once a country leaves the eurozone, the monetary union becomes more like a system of pegged exchange rates. And pegged exchange rates are open to destabilising speculation at times of economic divergence.
A Greek exit from the euro (dubbed ‘Grexit’) is seen as undesirable by most Greeks and by most politicians in the rest of Europe. The optimum for both sides collectively would be a compromise, which saw more modest cuts by Greece and the eurozone remaining intact. By both sides seeking to maximise their own position, the Nash equilibrium is certainly not the best outcome.
But as long as the troika believes that the Greeks are likely to vote Yes to the proposed bailout terms, it still hopes to get the outcome that is best from its point of view – an outcome that would probably involve regime change. And as long as the Greek government hopes that a No vote will force the troika to think again and come back with less austere proposals, it still hopes to get the outcome that is best from its point of view. But the outcome of this game of ‘chicken’ could well be Grexit and a Nash equilibrium that neither side wants.
But while the endgame is being played out by politicians, people in Greece are suffering. Policies of severely depressing aggregate demand to turn a large budget deficit into a primary budget surplus have led to the economy shrinking by 26%, overall unemployment of 27% and youth unemployment of over 60%. The Greeks truly believe themselves to be stuck between a rock and a hard place.
The following articles look at the nature of the ‘game’ being played and at the effects on the Greek economy, both of the proposed austerity package proposed by the troika and Grexit. They also look at the knock-on effects for the eurozone, the EU and the global economy.
Can game theory explain the Greek debt crisis? BBC News Magazine, Marcus Miller (26/6/15)
Against the Grain: What Yanis Varoufakis can learn from a real game theory master – Nicola Sturgeon City A.M., Paul Ormerod (24/6/15)
John Nash’s Game Theory and Greece Bloomberg, Mohamed A. El-Erian (29/5/15)
The Greek crisis: that 1931 moment The Economist, Buttonwood column (23/6/15)
How game theory explains Grexit and may also predict Greek poll outcome The Conversation, Partha Gangopadhyay (1/7/15)
Greece debt crisis: Tsipras may resign if Greeks vote yes BBC News (30/6/15)
Greek debt crisis: Is Grexit inevitable? BBC News. Paul Kirby (29/6/15)
Existential threat to euro from Greek exit BBC News, Robert Peston (29/6/15)
How I would vote in the Greek referendum The Guardian, Joseph Stiglitz (29/6/15)
Greece in chaos: will Syriza’s last desperate gamble pay off? The Guardian, Paul Mason (29/6/15)
What happens if Greece defaults on its International Monetary Fund loans? The Telegraph, Mehreen Khan (30/6/15)
For Greece’s international creditors, regime change is the ultimate goal The Telegraph, Jeremy Warner (29/6/15)
Europe has suffered a reputational catastrophe in Greece The Telegraph, Ambrose Evans-Pritchard (2/7/15)
Questions
- What is meant by a primary budget surplus?
- What was the troika’s proposal on the table on the 26 June that was rejected by the Greek government?
- What was the Greek government’s proposal that was rejected by the troika?
- Explain the decision trees outlined in the first BBC article below.
- In terms of game theory, what form of game is being played?
- Are the negotiations between the Greek government and the troika a prisoners’ dilemma game? Explain why or why not.
- Does the game being played between the SNP and the Conservative government in the UK offer any useful lessons to both sides in the negotiations over Greece’s possible bailout and its terms?
- Does a No vote in the referendum on 5 July imply that Greece must leave the euro? Explain.
- What would be the effects of further austerity measures on aggregate demand? What benefits to the Greek economy could be achieved from such measures?
- Why may pegged exchange rates be regarded as the worst of both worlds – a single currency in a monetary union and floating exchange rates?
ECB launches new series of targeted longer-term refinancing operations 
