Sweden’s central bank: Stockholm syndrome

Sweden’s central bank: Stockholm syndrome

Sweden’s central bank: Stockholm syndrome

By Christian Odendahl, 19 November 2014
From Financial Times

Link to press quote:
http://www.ft.com/cms/s/0/638e830a-6e68-11e4-bffb-00144feabdc0.html#axzz3JbKrxpp7

ECB threatened to end funding unless Ireland took bailout, letters show

ECB threatened to end funding unless Ireland took bailout, letters show

ECB threatened to end funding unless Ireland took bailout, letters show

06 November 2014
From International New York Times

Link to press quote:
http://www.nytimes.com/2014/11/07/business/international/ecb-threatened-to-end-funding-unless-ireland-took-bailout-letters-show.html?_r=1

Does a eurozone slump make Brexit more likely?

Does a eurozone slump make Brexit more likely?

Does a eurozone slump make Brexit more likely?

Written by Simon Tilford, 10 November 2014

Two years ago the British economy was performing in line with the eurozone’s. Since then, it has grown rapidly and the country’s Office for National Statistics (ONS) has announced that the 2008-9 recession was shallower than previously thought (see chart 1). Over this period, the eurozone economy has stagnated, leading to a big gap in growth rates. Indeed, the UK has now performed better since the first quarter of 2008 than Germany, the eurozone’s supposed ‘star performer’, let alone the eurozone as a whole. Is this superior performance likely to continue? And what will it mean for the UK’s relations with the eurozone and its membership of the EU?

The UK suffered one of the biggest economic shocks of any member of the EU in 2008. The crisis led to a large contraction in financial and business services, a major industry in the UK: Britain faced one of the biggest banking sector crises of any EU country, with the government having to provide unprecedented support to crippled financial institutions. How has the UK done not only much better than comparably hard-hit eurozone economies, but also better than less hard-hit ones?

Chart 1: Economic growth


Source: Haver

The principal reason for the UK’s outperformance is macroeconomic policy. First, Britain has imposed less austerity than other hard-hit members of the euro. The UK’s coalition government has talked tough on the need for austerity but since 2012 has eased up considerably; in 2014 fiscal policy has boosted growth slightly. The UK’s structural deficit – the government’s deficit adjusted for the economic cycle – is on course to rise this year and is now the highest in the EU (see chart 2). Second, the Bank of England has pursued a much more expansionary monetary policy than the ECB. It cut interest rates faster and more aggressively than the eurozone’s central bank and has held them at record low levels first in the face of higher than target inflation and more recently against the backdrop of a recovering economy. The Bank of England also launched quantitative easing in 2009, which succeeded in stimulating the economy.

Chart 2: Structural budget deficits (per cent, GDP)


Source: Haver

A number of other factors have no doubt contributed to the UK’s stronger performance. Crucially, the British government moved quickly to clean up the country’s banks, taking stakes in the hardest-hit and winding up others. Partly as a result, credit growth has not been as weak as elsewhere. And timely action to recapitalise the banking system means that British banks are in a better place to respond to increased demand for credit than those in many eurozone economies.

The structure of the UK labour market has no doubt contributed to the relative resilience of private consumption. After the crisis, unemployment rose less than one might expect, given the steep drop in output. There appears to have been a number of reasons for this: firms were loath to let go hard to replace skilled workers, businesses slashed labour-replacing capital investment; and a large number of workers moved from full to part-time work. This helped prevent the huge increases in unemployment and hence collapse in consumer demand (and investment) seen in parts of the eurozone.

The surprisingly strong rebound in house prices does not seem to be having much of an impact on economic growth.  A strong housing market can boost consumption as home-owners borrow against the rising value of their homes or run down their savings (believing that the rising value of their homes cushions them from future risks to their income.) But there is little equity release taking place and house price inflation is heavily concentrated in London; prices across much of the country remain pretty depressed.

Finally, the weakening of sterling in the wake of the crisis has not enabled the UK to steal a march on the eurozone by virtue of having a cheap currency. Sterling fell from €1.50 in January 2007 to a low of €1.09 in January 2009, before recovering steadily to €1.27 in October 2014. At such, it is not undervalued relative to its long-term trend, trading at around the level it was at just prior to its ejection from the European Exchange Rate Mechanism (ERM) in 1992 (see chart 3). Secondly, Britain’s trade deficit with the eurozone has ballooned since the beginning of 2008 as growth in British domestic demand has outpaced that of the eurozone. The UK is certainly not guilty of ‘beggaring’ the eurozone: quite the reverse.

Chart 3: Pound-sterling’s real effective exchange rate


Source: World Bank

Can the UK’s outperformance be sustained?  Business investment is finally recovering, making the economy less dependent on consumption. Employment is rising quite strongly, and the number of full-time jobs is rising and the total of part-time ones shrinking. The fall in unemployment should eventually see real wage growth turn positive. Strikingly, the UK has experienced one of the largest falls in real wages of any EU state since 2008, which partly explains way immigration has become such a salient political issue.

Monetary policy will remain expansionary. The Bank of England is likely to delay raising rates until it is clear that recovery is firmly established and real wages have started to rise. That could be considerably longer than the markets currently assume. Although the UK economy is growing strongly, inflation pressures remain weak. Consumer price inflation stood at just 1.2 per cent in September (core inflation was 1.6 per cent). Given the high levels of corporate and household debt, any increases will be gradual. Once the general election to be held in May 2015 is out of the way, fiscal policy will be tightened somewhat irrespective of the outcome, holding back economic growth a bit.

The biggest cloud on the horizon is foreign trade. Exports to non-EU markets are up by around a third since 2008, whereas those to the eurozone are yet to return to 2008 levels. The UK’s sizeable current account deficit (of around 4 per cent of GDP) is entirely accounted for by trade with the eurozone. If, as appears all but certain, eurozone growth remains depressed for years, the UK’s deficit with it will continue to rise. And when the ECB finally launches QE, the euro is likely to weaken against sterling, exacerbating the trade imbalance. Despite the size of the UK’s external deficit, there is a risk of sterling strengthening too much, undermining the gradual recovery in investment in the tradable sector.

Chart 4: The UK’s current account balances


Source: Office for National Statistics

The UK’s economic prospects look reasonably good, but are flattered by the dire outlook for the eurozone. After expansion of a little over 3 per cent in 2014, most forecasters expect the British economy to grow by 2.5-3 per cent in 2015 and around 2.5 per cent the year after. Even the European Commission, which is notoriously bullish on the eurozone (resulting in it having to repeatedly revise down its numbers), expects the difference between eurozone and UK growth rates to be around 1 per cent in both 2015 and 2016. Most other forecasters expect a bigger gap.

What does this mean for relations between the UK and the eurozone? On the face of it, there is no reason why much stronger growth in the UK than in the currency union should harm relations. After all, Britain grew more rapidly than the eurozone in the decade running up to the crisis, and this coincided with a period of almost unprecedentedly good EU-UK relations. A Britain whose economy is expanding reasonably quickly could be more at ease with itself and with the rest of Europe. Concerns over immigration could dissipate, with attitudes returning to the grudging acceptance seen prior to the crisis. It could also become harder for the rest of the EU to ignore UK concerns about particular issues, helping to address the widely held perception in Britain that the country is unable to defend its interests.

However, there is a less optimistic scenario. Although real wages should start to edge up with the tightening of the labour market, it will take many years before they return to pre-crisis levels. As a result, popular resentment over immigration will remain a problem, especially as immigration from struggling eurozone countries set to remain high. At the same time, the UK’s net contribution to the EU budget will rise, reflecting its increased wealth relative to the EU average. This is likely to be happening at a time when Britain is becoming increasingly marginalised within the EU, partly because of its own lack of engagement but partly because it is not a member of the eurozone. Finally, the proportion of the UK’s trade conducted with the EU will fall steadily from the current 45 per cent. Although EU membership makes it much easier for UK exporters to access fast-growing emerging markets, eurosceptics will still cite the declining relative importance of EU trade as evidence of the diminishing benefits of being in the single market.

May’s general election will have a large bearing on which of these two scenarios is closest to reality. If the Labour Party wins or is able to form a coalition with the Liberal Democrats, there is a good chance it could be closer to the first. Relations with the EU would certainly be better than under the current government, although tensions over the EU budget, immigration and management of the eurozone would still be considerable. However, such a government will need a healthy majority if it is to resist pressure from eurosceptics within its own ranks to adopt a tougher line with the EU.

A Conservative administration, especially one with a small majority or even governing as a minority, will struggle to avoid the latter scenario. Much of the party is now eurosceptic and is bound to be even more so after the election. Egged on by the media, much of the party could agitate to leave the EU in 2017’s membership referendum. Antagonistic relations with the EU would isolate Britain, allowing eurosceptics to argue that it cannot defend its interests. With some justification, they would use rising budgetary contributions to argue that Britain is paying for the eurozone’s failure to get on top of its problems. And the fall in the proportion of UK trade done with the EU will be grist to the mill of those Conservatives who argue that the benefits of single market membership are exaggerated. In this case, economic outperformance could hasten Britain’s exit.

Simon Tilford is deputy director of the Centre for European Reform.

Stock markets rally as ECB chief suggests further eurozone stimulus

Stock markets rally as ECB chief suggests further eurozone stimulus

Stock markets rally as ECB chief suggests further eurozone stimulus

By Simon Tilford, 06 November 2014
From Voice of America

Link to press quote:
http://www.voanews.com/content/europe-stock-markets-rally-further-eurozone-stimulus/2510931.html

A Greek programme for Greece

A Greek programme for Greece

A Greek programme for Greece

Written by Christian Odendahl, 05 November 2014

Greece is currently negotiating its exit from the various programmes and ‘bailouts’ with its European and international creditors. Greece is still too weak to stand on its own, financially. But the problem is not the debt level alone, which is manageable over the short term because debt servicing costs are relatively low. The main issue is how to make Greece a prospering economy within the euro, after an epic economic depression and in the face of waning public support for further reforms. The country’s growth prospects will ultimately determine how much of Greece’s debt will get repaid. Of course, European policy-makers and the IMF could continue to muddle through, and Greece is unable to force them to change course. But with a crucial presidential election looming in early 2015 that could end the current government’s term and bring Syriza, the far-left party, to power, it is time to take stock. The Greek programmes had severe shortcomings that proved costly, both in terms of economic damage and in terms of popular legitimacy. What is needed is Greek ownership of further reforms, and a focus on long-term economic growth.

Taking stock

Over the last four years of crisis, Greece has never been the only – or even the main – problem in the eurozone. As a result, the eurozone’s Greek programmes have served other purposes: they have set a tough example for other countries, so they did not seek European money lightly; they have sought to prevent contagion to other countries and hence blocked a restructuring of Greek debt for a long time; by being tough, they have tried to preserve the political support in Europe’s northern core that might be needed if the crisis were to spread; and they have aimed to spare the fragile European banking system from ‘another Lehman’ because the Europeans failed to fully restructure and recapitalise their banks after 2008. At the same time, Greek society and its political leadership were ill-prepared for the crisis. They have struggled to collaborate with the IMF and the Europeans, neither of which knew the country well, in order to design an effective and inclusive reform programme.

The resulting programmes focused on cutting back spending and on sparing European and Greek private bondholders from losses. These wrenching fiscal cut-backs, together with the threat of a euro exit, predictably led to an economic depression: Greek GDP is currently 20 per cent below its 2009 level and hardly growing; unemployment stands at 26 per cent, three quarters of which is long-term unemployment. Greek public finances do show a primary surplus, that is, a surplus before the costs of servicing public debt have been subtracted. But with crumbling nominal GDP, Greek public debt has risen to 176 per cent of GDP – despite a massive haircut on private bondholders in 2012. Importantly, the depression has eroded the initial public support for an overhaul of the Greek economy and governance.

Structural reforms, meanwhile, focused on issues that were seen as crucial for Greece’s public finances: tax collection, cuts to public sector jobs, salaries and welfare, and privatisation. Some of these reforms were certainly needed, and Greece has been one of the OECD’s busiest reformers, according to the Paris organisation’s ‘reform responsiveness indicator’.

But they did little to raise Greece’s growth potential: public bureaucracy, regulation, the judicial system and land rights issues continue to weigh heavily on the Greek economy.

  • This recent EU Commission paper found that these constraints hold Greek exports back rather than uncompetitive prices or wages; 
  • Earlier this year, the OECD argued that Greek business could save €3.3 billion euro annually if the government removed unnecessary administrative burdens. 
  • The OECD also identified 555 regulations that severely hamper competition in the Greek economy.

Thus, the goal should be an overhaul of the way in which the political system and public bureaucracy works, which requires the support of the whole political spectrum, the public and the bureaucracy itself. It also requires action to reduce clientelism, which to a large extent is currently just on hold because there is very little public money to spend, or public jobs to fill. These crucial reforms could take a decade – some even a generation – rather than a couple of years to implement.

The current state of the programmes

Overall, therefore, the limited political capital in Greece was not spent on what was most critical for the long-term success of its economy, and hence, its public finances. As a consequence, Greece’s European creditors are less likely to be repaid, despite extending loan maturities and pretending that Greece could grow strongly and run politically unrealistic budget surpluses for years. The current round of negotiations between the Greek government and the ‘troika’ of the European Commission, the IMF and the ECB over the final review of the second adjustment programme could now be the breaking point.

The government cannot agree to the troika’s demands – a highly unpopular pension reform and making it easier to lay off workers collectively, among other things – in return for the final tranche of €7.2bn. In addition, the government would like to exit the programme entirely before the elections, foregoing further IMF funds pencilled in for 2015 and 2016, a plan that the troika rejects. Finally, it would like to reduce the amount of intrusive monitoring and outside interference, despite needing at least a precautionary credit line from either the Europeans or the IMF before it can safely return to markets – credit lines that usually come with significant outside monitoring.

The reason is clear: politically, the government has its back against the wall, ahead of the presidential election in February 2015. Under the Greek constitution, the president is elected by the parliament, and the winning candidate will need a three-fifths majority (180 votes). At present, the government only has 154. The remaining 26 votes need to come from either the former coalition partner DIMAR or independent MPs, both of which loath to help the government. If the parliament fails to elect a new president, there will be snap elections, one year ahead of time. The current government coalition is highly unlikely to win: the far-left Syriza is leading in the polls with roughly 33 per cent, compared to the main governing party, New Democracy, at just 26 per cent and PASOK, the junior coalition partner, down to 6 per cent.

If Greece elects Syriza, the eurozone would be back in unchartered territory. Syriza has vowed to reverse cuts to public spending, wages and pensions, and to cancel or at least substantially renegotiate the agreement with the troika. Given that Greece cannot stand on its own, financially, unless it defaults unilaterally on its debt, both sides would be on a collision course. Greece would be destabilised and less likely to repay its debt. It also might spook investors beyond Greece. Of course, the ECB has made it clear that it intends to prevent contagion from spreading across the eurozone. But the collision with Greece might come at a bad time. If eurozone growth continues to disappoint, the ECB has to use further unconventional measures (thereby enraging the German public), and Italy challenges the current policy course more openly, a collision with Greece might add fuel to the fire.

What Europe should do

The widely respected mayor of Thessaloniki, Yiannis Boutaris, has recently called for a national unity government of all the major parties. The EU should take the cue and try to find a long-term solution to Greece’s economic woes and its public debt that has broad support across the political spectrum; that ensures Greek ownership of further reforms; and that, based on local knowledge, removes the most binding constraints that currently hold Greek growth back.

One way would be to create a Greek reform council, consisting of Greek experts and representatives of Greek civil society, which would draft a long-term reform programme that the major parties in parliament – and the Greek public – can agree on. This programme should, at the same time, leave enough room for democratic decisions on policies. Europe and the IMF should continue to offer their technical help but mandate the Greek reform council with the monitoring of its new reform programme. In addition, a clear agreement should be made: that after a successful completion of the programme, Greek debt will be written down to a sustainable level. How much debt is sustainable is impossible to predict and depends on Greek growth, but it would be an effective incentive to make sure the reform council is a success. In the meantime, the European Stability Mechanism (ESM), Europe’s main bailout fund, should extend a precautionary credit line that the Greek government can draw on in case the markets are not willing to fund it at reasonable rates, conditional on the progress of the reforms.

Why would the current leader in the polls, Syriza, agree to such a Greek reform programme and reform council, just before the opportunity to come to power? Syriza’s problem is that it has to prove to the Greek public that it would not further destabilize the Greek economy. The threat of a euro exit scares the public. According to the latest Eurobarometer poll, 59 per cent of the Greek population still approve of the euro – which, strikingly, is above the eurozone average, and considerably above Italy’s 43 per cent. A genuinely Greek reform programme and a stable, long-term agreement with the rest of the eurozone and the IMF might give Syriza the credibility it needs. If early elections in the summer of 2015 were part of the agreement, Syriza’s chance of winning an outright majority might actually be higher than it is now.

What is more, Alexis Tsipras, Syriza’s leader, could use this Greek reform programme to discipline his party, which is a loose association of various socialist groups. At the same time, he would have enough leeway to push through some Syriza policies. Finally, Tsipras would preside over a light-touch monitoring of a genuinely Greek reform agenda, rather than having intrusive troika visits every couple of months; and he could avoid a stand-off with the EU that deep down he knows he cannot win without causing further short term damage to the Greek economy.

The eurozone would gain from a realistic long-term strategy for Greece that ensures a maximum amount of useful reform and economic growth. Such a long-term solution would also, despite writing down Greek debt, ensure that Greece’s official debt would get repaid as much as possible, and end the current charade of extend and pretend. If eurozone policy-makers continue to muddle through with Greece against a fading momentum for change, the Greek economy will remain half-reformed and continue to struggle inside the euro. Eventually, the political tension might spread beyond Greece.

Christian Odendahl is chief economist at the Centre for European Reform.

Commission defers budget battle

Commission defers budget battle

Commission defers budget battle

By Christian Odendahl, 30 October 2014
From European Voice

Link to press quote:
http://www.europeanvoice.com/article/commission-defers-budget-battle/

CER conference on 'Is Europe's economic stagnation inevitable or policy-driven?'

CER conference on 'Is Europe's economic stagflation inevitable or policy driven?

CER conference on 'Is Europe's economic stagnation inevitable or policy-driven?'

03 October 2014 - 04 October 2014

Location info

Ditchley Park
Oxfordshire

Event Gallery

Why the Eurozone suffers from a Germany problem

Why The Eurozone Suffers From A Germany Problem

Why the Eurozone suffers from a Germany problem

By Simon Tilford, 27 October 2014
From Social Media Journal

Link to press quote:
http://www.social-europe.eu/2014/10/eurozone-suffers-germany-problem/

Europe's crisis that won't go away

Europe's crisis that won't go away

Europe's crisis that won't go away

By Simon Tilford, 21 October 2014
From BBC News

Link to press quote:
http://www.bbc.co.uk/news/world-europe-29702017

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