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(s):

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.

Comments

Added on 20 Nov 2014 at 16:10 by Dr. Christopher Tsoukis, London

A 3rd point in continuation to the earlier comment:
Future debt interest payments can be linked to the growth rate (a Sachs proposal, in fact) - the higher the growth rate, the greater the fraction of the debt to which the interest payment applies. It gives all parties incentives, a win-win solution.

Added on 20 Nov 2014 at 16:07 by Dr. Christopher Tsoukis

A very balanced and knowledgeable piece. I do not disagree with anything, but my I add a cuple of extra points (actually, 3!):
1. The cost to Greek society is much higher than the 20% loss in (nominal) GDP betrays, as: prices have gone up, taxes have gone up significantly, pension funds have been hit hard because of the debt haircut, much reduced contributions and increased outlays, and the costs are asymmetric (unemployment rate of 26% and youth unemployment >50% says it all).
2. From now on, primary surpluses must be permanent so (this is proposal to the country) they must be written into the Constitution.
3.

Launch of CER policy brief 'Unlocking Europe's capital markets union'

Launch of CER policy brief 'Unlocking Europe's capital markets union'

Launch of CER policy brief 'Unlocking Europe's capital markets union'

11 December 2014

With Hugo Dixon, editor-at-large, Reuters News, and Jo Johnson MP, minister of state for Cabinet Office.

Location info

London

Event Gallery

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(s):

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(s):

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(s):

http://www.bbc.co.uk/news/world-europe-29702017

The eurozone’s German problem

The eurozone’s German problem

The eurozone’s German problem

Written by Simon Tilford, 20 October 2014

There is a deal to be done to save the euro from deepening crisis. The outlines of it are generally accepted outside Germany: structural reforms in France and Italy and elsewhere combined with measures to strengthen their long-term fiscal positions; and in return, a large pan-eurozone fiscal stimulus and quantitative easing (QE) by the ECB. This offers the best way out of the current impasse in the eurozone, not just for the periphery but also for Germany. But it will take a political earthquake  for the Germans to back such a deal. Instead, the stability of the euro and the futures of the participating countries will continue to be vulnerable to the short-term exigencies of German domestic politics. This is a recipe for stagnation, deflation and political populism in France and Italy. It may culminate in a breakdown in relations between Germany and these countries and could even lead to eurozone break-up.

Why has Germany assumed such pre-eminence in the eurozone? How is it that German policy-makers from the finance minister, Wolfgang Schäuble, to the head of the Bundesbank, Jens Weidmann, can wag their fingers at everybody else for causing the eurozone crisis, while responding dismissively to any suggestion that Germany might be part of the problem? Germany’s initial pre-eminence following the crisis was understandable – it is a major creditor and in the early stages of any debt crisis, creditors tend to call the shots. However, as a debt crisis wears on, the creditors’ resolve typically weakens as the impoverishment of the debtors rebounds on the creditors politically and economically, and the debtors call the creditors’ bluff by threatening to renege on their debts.

This has not happened in the eurozone, with Germany (and other creditor states) able to subordinate the interests of the eurozone as a whole to their own perceived interests. The debtors have put Germany under little pressure to share the burden or to reform its own economy. There appear to be two principal reasons for this. One is that many members of the eurozone see Germany as a model to emulate rather than a significant part of the problem. The second reason is that even those who understand that the structure of the German economy is a threat to the stability of the euro have been circumspect about openly criticising Germany for fear of provoking a backlash against the euro in the country. This softly, softly approach has been bad for Germany itself as it has distracted attention from the country’s formidable structural problems, and encouraged a belief that the country does not need to compromise and can afford to say no to everything.

This deference to Germany is puzzling. While it is the largest economy in the eurozone, it is hardly dominant, accounting in 2013 for 29 per cent of eurozone GDP as opposed to France’s 21 per cent, Italy’s 16 per cent and Spain’s 11 per cent. Economic growth in Germany has certainly rebounded faster since the crisis than in other eurozone countries. But the German recovery now seems to have run its course, with exports to both European and non-European markets under pressure and domestic demand being held back by weak levels of public and private investment (see chart 1). Even the German government expects growth of just 1.3 per cent 2014 and 1.2 per cent in 2015.

Chart 1: Economic growth (Q1 2008 – present)

Source: Haver

Chart 2: Economic growth (1999 – present)

Source: Haver

There have been some tentative signs of rebalancing over the last 12 months – with growth in domestic demand outpacing overall economic growth. But Germany remains chronically export-dependent – its current account surplus is on course to exceed 7 per cent of GDP in 2014 for the second successive year. The country is certainly not the ‘locomotive’ of the eurozone economy, as some journalists like to call it, but a drag on it. Some German policy-makers argue that stronger domestic demand in Germany would have little impact on other eurozone economies, but they are being rather disingenuous. The government has attributed the economy’s loss of momentum over the course of 2014 to weak eurozone demand, so cannot simultaneously deny that what happens in Germany has no impact on other eurozone economies. With Germany accounting for almost 30 per cent of the eurozone economy, what happens to aggregate demand in Germany clearly has a major impact on the level of demand across the eurozone as a whole.

German policy-makers tend to bridle at any suggestion that they may be guilty of mercantilism and there is indeed little to suggest that they are consciously setting out to beggar their neighbours. But there is no denying that Germany remains dependent on foreign demand to bridge the very large gap between what it produces and what it consumes, and that this is not a replicable model. An economy as small and open as Ireland’s can rely on wage cuts and rising exports to underpin recovery. But big economies in which trade plays a lesser role cannot do this, at least not all at the same time. Eurozone member-states need to increase the size of the economic pie rather than fighting for bigger shares of a constant pie.

Chart 3: Current account balances (per cent, GDP)

Source: Haver

Indeed, Germany’s strong employment performance – unemployment stands at just 5 per cent and the employment rate at a record high – would look quite different were it not for that foreign demand. Employment has also risen by more that would be expected from weak economic growth, suggesting that German employers (like their UK counterparts) have been taking on more workers in preference to boosting capital expenditure (which is no higher than it was in the first quarter of 2008). Moreover, the tightness of the labour market has not yet fed through into a meaningful recovery in real wages after years of wage restraint. Real wages should rise by around 1 per cent in 2014 (after falling last year), but this partly reflects unexpectedly weak inflation. Indeed, far from experiencing a surge (as many in German commentators feared when the ECB held interest rates lower than they thought Germany needed), German inflation fell to just 0.8 per cent in September, compounding deflation pressures across the eurozone.

Germany’s public finances are in good shape, allowing it to portray itself as a saint among fiscal sinners (German policy-makers still stress above all else the role of fiscal ill-discipline in causing the crisis). The government will again run a small surplus this year (see chart 4) compared with substantial deficits elsewhere. With growth in the German economy faltering, this would be the ideal time for the government to boost its spending. And there is no shortage of things it could spend the money on. Levels of public investment are very low in Germany, even by Western European standards. Indeed, net public investment is negative (that is, Germany is not investing enough to replenish the country’s public capital stock), storing up problems for the future (see chart 5). Germany could also boost defence spending, which is languishing at just 1.3 per cent of GDP, and so help to improve its ability to play a useful role in providing for Europe’s security. Cuts in incomes taxes and/or value-added-taxes could also give impetus to the moderate upturn in private consumption that is underway, in the process helping the economy to shake off the impact of weaker exports.

Chart 4: Government deficits (per cent GDP)

Source: Haver

Chart 5: Net public investment (per cent, GDP)

Source: Haver

How is the German government likely to respond to the slowdown in Germany and the worsening crisis across the eurozone? It will probably continue to show some flexibility regarding the fiscal targets facing other members of the eurozone such as France and Italy, while sticking publicly to its hard line. There will no doubt be a bit of fiscal easing at home, but nothing dramatic, with the government citing the need to comply with a constitutionally-binding rule requiring the government to run a balanced budget, which comes into force in 2016. Taken together, these slight shifts in Germany’s position will do little to alleviate the pressures on the eurozone economy (a much bigger stimulus is required to ward off slump and deflation) or to rebalance the German economy. Meanwhile, Germany will remain the biggest obstacle to QE by the ECB, which would aim to boost inflation expectations and hence the readiness of firms and households to spend. Were Germany to support such action, other sceptical countries would no doubt fall in behind it.

If, as is increasingly likely, the ECB pushes ahead with QE despite German opposition, its effectiveness will probably be undermined by the lack of a major fiscal stimulus to the eurozone economy. The ECB may also struggle to bring about a substantial fall in the euro because of the size of the eurozone’s trade surplus, which boosts demand for euros. (The eurozone’s trade with the rest of the world would be broadly balanced were it not for Germany.) And if QE does succeed in weakening the euro without an accompanying programme of fiscal stimulus or aggressive steps to rebalance the German economy, it risks being seen by the eurozone’s trade partners as a mercantilist move in a global economy characterised by very weak demand. One consequence could be to further weaken the chance of brokering a meaningful Trans-Atlantic Trade and Investment Partnership (TTIP). It could also further unbalance the UK economy, strengthening Britain’s eurosceptics.

Germany’s current intransigence poses a far greater risk to its economic and political interests than the ‘grand bargain’ outlined at the beginning of the piece. Germany cannot afford the impoverishment of the eurozone. The rapid slowdown in world trade, in particular trade with China, has shown this. If the German economy is to grow sustainably, it will be as part of a healthy eurozone economy, in which Germany is deeply enmeshed through trade and investment. Nor does Germany’s current uncompromising stance limit the exposure of German taxpayers to bail-outs of other members. Aside from the impact that the ongoing slump across the eurozone will have on German growth (and hence public finances), debt burdens will reach unsustainable levels in more eurozone countries. The inevitable debt defaults in these countries will impose incalculable costs on the German taxpayer.

German politicians, like all politicians, are focused on getting re-elected, and they believe that their current approach to the eurozone is the best route to that. But long-term threats eventually become immediate threats. Germany needs a proper debate about the choices facing it, much as the German government has repeatedly demanded of the French, Italians and others. Unfortunately, there is little sign that this will happen without greater outside pressure. The French and Italians need to force this debate by making clear to Berlin that it cannot assume that the euro will endure in its current form without Germany making significant compromises. By ending their deference to the German government, they would hopefully expose the weakness of Germany’s bargaining position and prompt a more objective discussion within Germany of its own structural problems and how they play into the eurozone crisis. There is a risk that such a confrontation could play into the hands of the right-wing Alternative für Deutschland (AfD), which has already tapped into anti-euro sentiment. But Germany’s domestic politics should not be allowed to stand in the way of a solution to the crisis, any more than French or Italian politics should be allowed to do so. If Germany really is as pro-European as its politicians argue, its grand coalition should be able to convince enough Germans that a grand bargain is in the country’s own interests.

Simon Tilford is deputy director of Centre for European Reform.

European policy makers at odds as eurozone’s economic woes deepen

European policy makers at odds as eurozone’s economic woes deepen

European policy makers at odds as eurozone’s economic woes deepen

By Simon Tilford, 14 October 2014
From Wall Street Journal

Link to press quote(s):

http://online.wsj.com/articles/european-policy-makers-at-odds-as-eurozones-economic-woes-deepen-1413320253

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