Governments against the euro zone

Christine Lagarde, in her first official speech as President of the ECB, called for the implementation of a new policy mix to allow the Eurozone to develop all its growth and employment potential. The complementarity between fiscal and monetary policy should, according to the new President of the ECB, allow such a scenario. The Eurozone could then have more growth autonomy and a greater capacity to decide for itself.

Christine Lagarde will have to be convincing because governments do not take the demands of the central bank seriously.
Mario Draghi, before her, had already, and from the beginning of his mandate, called for a rebalancing of economic policies. The request of Christine Lagarde shows that the former President of the ECB has never been listened to or taken into account.
Draghi committed to a strategy of low interest rates to improve the public finances solvency. By pushing interest rates down, he facilitated more aggressive fiscal policies and structural reforms to improve the growth profile of the Eurozone economy.. Governments have never engaged on this point.

The ECB has, since the arrival of Mario Draghi, carried out an accommodative monetary policy. In the summer of 2012 the ECB became the lender of last resort of the Euro Area, thus guaranteeing the safeguarding of the banking and financial system. It then lowered policy rates to around 0% and then launched its QE in March 2015. All these unorthodox policies have been criticized from all sides as being excessive and in no way boosting growth or inflation.

How could it have done when the fiscal policy of the Euro zone is restrictive since 2011? The structural primary surplus (i.e. corrected for cyclical effects) since 2012 reflects a fiscal drag. In no case has there been fiscal stimulus at the euro area level since 2010 (the data are calculated by the IMF and a larger deficit reflects a fiscal stimulus).
At the time, 2008/2009, the collapse of the economy had caused this large public deficit. But as soon as growth resumed, with the revival of the G20 decided in London in April 2009, Europeans have become systematically restrictive again. The ECB then played the same role as the Commission, helping to accentuate the six-quarter recession in the Eurozone.

The Eurozone fiscal policy has never been conducive to supporting activity and enhancing growth.
The primary fiscal surplus has been around 1% of potential GDP since 2013 and has not moved since. The rigor implemented in 2011/2012, which resulted in the very long recession, was never questioned. The budget texts put in place in 2013 to signal the seriousness of the budget options and to reassure the financial markets have not, in fact, helped to strengthen growth in the Eurozone.

One may wonder whether accommodative monetary policy has not been the pretext for not adopting a proactive fiscal policy. Another interpretation, monetary policy became frankly accommodating only because Draghi had the perception that governments and the Commission would never let go on fiscal policy. Since the ECB adopted a strategy to support growth, it was no longer necessary to do so at the Eurozone level.
Draghi has allowed governments not to reform, not to promote growth, to criticize the inefficiency of monetary policy with impunity while being able to complain about populist excesses.

Will Christine Lagarde fall into the same trap as Draghi?

Soaring US deficit is a source of concern

When our grandchildren study economics one day, will they systematically have to add a dummy variable* to their econometric equations for the period covering the Trump administration? Will the US economy over this period have something of a “special status” due to Trump’s and Congress’ decisions? This question is worth raising in light of moves to cut taxes and raise spending, with the ensuing effects on the appalling US public deficit.

The state of public finances is the trickiest of questions. The sustainable rise in the public deficit seems to show that the economy is undergoing a severe recession, yet this is far from true as Janet Yellen took the economy to full employment (see analysis from Jason Furman). So economic stimulus moves from the White House and Congress raise very real questions on the rationale behind this policy. Governments do not embark on economic stimulus programs when the country is running on full employment, otherwise major long term imbalances are created, which are bad news for all concerned. Continue reading

Euro Area: A new policy mix that could favor growth

Last week was important may be decisive for the Euro Area. For the first time since the end of 2008, just after Lehman bankruptcy, government policies and monetary policy will both support economic activity on the same side. They will support internal demand in order to boost growth and employment.

This can be a game changer. Until now and since 2011 monetary strategy was accommodative but governments were committed to stabilize their public finance and their debt. This policy mix was compatible with an economic dynamic that requires fine tuning. This was not compatible with the drop of activity seen since spring 2011. The policy mix change seen last week reflects mainly a change in the European Commission policy as the EC forecasts a recession in 2013 after a recession in 2012. The situation does need a fine tuning but a deep change that recognizes that the Euro Area is still far from its potential trend and from full employment.
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