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January 31, 2014
A Brief Interview with Sergio Rebelo on the Euro-Area Economy
Last month, we at the Atlanta Fed had the great pleasure of hosting Sergio Rebelo for a couple of days. While he was here, we asked Sergio to share his thoughts on a wide range of current economic topics. Here is a snippet of a Q&A we had with him about the state of the euro-area economy:
Sergio, what would you say was the genesis of the problems the euro area has faced in recent years?
The contours of the euro area’s problems are fairly well known. The advent of the euro gave peripheral countries—Ireland, Spain, Portugal, and Greece—the ability to borrow at rates that were similar to Germany's. This convergence of borrowing costs was encouraged through regulation that allowed banks to treat all euro-area sovereign bonds as risk free.
The capital inflows into the peripheral countries were not, for the most part, directed to the tradable sector. Instead, they financed increases in private consumption, large housing booms in Ireland and Spain, and increases in government spending in Greece and Portugal. The credit-driven economic boom led to a rise in labor costs and a loss of competitiveness in the tradable sector.
Was there a connection between the financial crisis in the United States and the sovereign debt crisis in the euro area?
Simply put, after Lehman Brothers went bankrupt, we had a sudden stop of capital flows into the periphery, similar to that experienced in the past by many Latin American countries. The periphery boom quickly turned into a bust.
What do you see as the role for euro area monetary policy in that context?
It seems clear that more expansionary monetary policy would have been helpful. First, it would have reduced real labor costs in the peripheral countries. In those countries, the presence of high unemployment rates moderates nominal wage increases, so higher inflation would have reduced real wages. Second, inflation would have reduced the real value of the debts of governments, banks, households, and firms. There might have been some loss of credibility on the part of the ECB [European Central Bank], resulting in a small inflation premium on euro bonds for some time. But this potential cost would have been worth paying in return for the benefits.
And did this happen?
In my view, the ECB did not follow a sufficiently expansionary monetary policy. In fact, the euro-area inflation rate has been consistently below 2 percent and the euro is relatively strong when compared to a purchasing-power-parity benchmark. The euro area turned to contractionary fiscal policy as a panacea. There are good theoretical reasons to believe that—when the interest rate remains constant that so the central bank does not cushion the fall in government spending—the multiplier effect of government spending cuts can be very large. See, for example, Gauti Eggertsson and Michael Woodford, “The Zero Interest-rate Bound and Optimal Monetary Policy,” and Lawrence Christiano, Martin Eichenbaum, and Sergio Rebelo, "When Is the Government Spending Multiplier Large?”
Theory aside, the results of the austerity policies implemented in the euro area are clear. All of the countries that underwent this treatment are now much less solvent than in the beginning of the adjustment programs managed by the European Commission, the International Monetary Fund, and the ECB.
Bank stress testing has become a cornerstone of macroprudential financial oversight. Do you think they helped stabilize the situation in the euro area during the height of the crisis in 2010 and 2011?
No. Quite the opposite. I think the euro-area problems were compounded by the weak stress tests conducted by the European Banking Association in 2011. Almost no banks failed, and almost no capital was raised. Banks largely increased their capital-to-asset ratios by reducing assets, which resulted in a credit crunch that added to the woes of the peripheral countries.
But we’re past the worst now, right? Is the outlook for the euro-area economy improving?
After hitting the bottom, a very modest recovery is under way in Europe. But the risk that a Japanese-style malaise will afflict Europe is very real. One useful step on the horizon is the creation of a banking union. This measure could potentially alleviate the severe credit crunch afflicting the periphery countries.
Thanks, Sergio, for this pretty sobering assessment.
By John Robertson, a vice president and senior economist in the Atlanta Fed’s research department
Editor’s note: Sergio Rebelo is the Tokai Bank Distinguished Professor of International Finance at Northwestern University’s Kellogg School of Management. He is a fellow of the Econometric Society, the National Bureau of Economic Research, and the Center for Economic Policy Research.
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November 04, 2010
Some in Europe lag behind
Since around June, news of European fiscal deficits, financial markets stresses, potential sovereign debt defaults, or even a breakup of the euro zone has faded. The focal points of global economic policy have shifted to the sluggish recovery in developed countries and potential for further unconventional monetary stimulus.
A cursory look at a few key data reflects an improved European economic outlook from this summer. The simple dollar/euro exchange rate (see chart 1) shows that since June 1 the euro has appreciated nearly 15 percent against the dollar. While many different factors affect exchange rates—and increasing expectation of further monetary stimulus in the United States has helped the euro appreciate against the dollar—some of the appreciation seems to reasonably reflect the relative improvement of market sentiment about the fiscal situation in several European countries. Similarly, looking at the major stock indexes (mostly in Western European nations) shows a steady improvement from the lows of this summer, with the Euro Stoxx 50 index rising nearly 11 percent since June 1 (see chart 2). Thus, looking at most aggregate European data paints a picture of relative improvement, though most forecasters expect sluggish growth going forward. It's when one examines individual countries that it becomes clear some are lagging behind.
While the early stages of the European sovereign debt crisis centered on the fiscal scenario in Greece, market stress eventually spread to all the so-called PIIGS (Portugal, Ireland, Italy, Greece, and Spain) and even appeared to threaten the wider euro zone. Following an assortment of unprecedented interventions—highlighted by the 750 billion euro (approximately $1.05 trillion) rescue package from the European Union (through the European Financial Stability Facility) and support from the International Monetary Fund—market confidence slowly grew, and since this summer, various measures of financial market functioning have stabilized.
But while the threat of wider European contagion appears contained, fragilities remain. As has been documented in a variety of media reports, the recent improvement masks the individual euro zone peripheral countries' struggles with implementing fiscal consolidation, improving labor competiveness, resolving fragile banking systems, and staving off a crisis of confidence in sovereign debt markets.
Both bond spreads of individual European sovereign debt (over German sovereign debt) and credit default swap spreads show some stabilization for a few of the euro zone countries, but spreads in three countries—Greece, Ireland, and Portugal—are distinctly more elevated than the others (see charts 3 and 4).
The reasons for rising financing costs in these countries vary. In Ireland, for example, concerns about the Irish banking system (and the resolution of Anglo Irish Bank, in particular) were initially the driving cause. In Portugal, it was doubt over the implementation of necessary economic reforms that drove investor reluctance to provide financing; the recent adoption of austerity measures into the 2011 budget should alleviate some worry. But now much of the market action in both Irish and Portuguese bonds is focused on tough new bailout rules being implemented by the European Union.
On one hand, the renewed financing pressure brought upon these countries is less worrisome because of the backstop of the European Financial Stabilization Facility (EFSF). In fact, Moody's thinks it is unlikely there will be a euro zone default. Should market financing become too expensive for Greece, Ireland, or Portugal, the special purpose vehicle (SPV) imbedded within the EFSF could help by providing financing up to 440 billion euros ($616 billion).
But on the other hand, as part of the wider crisis prevention following the introduction of the EFSF, most European governments are implementing some level of fiscal austerity measures. From a political perspective, the implementation of these austerity measures varies widely, as demonstrated recently by the strikes in France over legislation trying to raise the retirement age. In addition to the uncertainty of implementing fiscal consolidation, there is pressure from the administrators of the EFSF to enforce burden-sharing on private bondholders in the event of any future bailout. This pressure is the primary impetus causing investors to shun the weaker peripheral countries.
One important player in this saga is the European Central Bank, which began buying European bonds for Greece, Ireland, and Portugal (among others) in conjunction with the EFSF announcement. Yet in recent weeks this bond buying has abated, and with money market pressures remaining in Europe, "something clearly has to give way," as Free Exchange wrote recently.
While aggregate market measures (exchange rates, stock indices, etc.) from Europe appear to be improving, a few specific countries face some hard challenges ahead.
By Andrew Flowers, senior economic research analyst in the Atlanta Fed's research department
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June 30, 2010
Keeping an eye on Europe
In June, a third of the economists in the Blue Chip panel of economic forecasters indicated that they had lowered their growth forecast over the next 18 months as a consequence of Europe's debt crisis. When pushed a little further, 31 percent said that weaker exports would be the channel through which this problem would hinder growth, while 69 percent thought that "tighter financial conditions" would be the channel through which debt problems in Europe could hit U.S. shores.
Tighter financial conditions also were mentioned by the Federal Open Market Committee in its last statement, where the committee noted, "Financial conditions have become less supportive of economic growth on balance, largely reflecting developments abroad."
In his speech today, Atlanta Fed President Dennis Lockhart identified the European sovereign debt crisis as one of the sources of uncertainty for the U.S. economy that he believes "have clouded the outlook." President Lockhart explicitly expressed his concern that Europe's "continuing and possibly escalating financial market pressures will be transmitted through interconnected banking and capital markets to our economy."
Negative effects from the European sovereign debt crisis can be transmitted to the U.S. economy through a number of financial channels, including higher risk premiums on private securities, a considerable rise in uncertainty, and sharply increased risk aversion. Another important channel is the direct exposure of the U.S. banking sector—both through holdings of troubled European assets and counterparty exposure to European banks, which not only have a substantial exposure to the debt-laden European countries but have also been facing higher funding costs. The LIBOR-OIS spread has widened notably (see the chart below), liquidity is now concentrated in tenors of one week and shorter, and the market has become notably tiered.
Banks in the most affected countries (Greece, Portugal, Ireland, Spain, and Italy) and other European banks perceived as having a sizeable exposure to those countries have to pay higher rates and borrow at shorter tenors. Although for now U.S. banks can raise funds more cheaply than many European financial institutions, some analysts believe that there's a risk that the short-term offshore dollar market may become increasingly strained, leading to funding shortages and, conceivably, forced asset sales.
Bank for International Settlements data through the end of December of last year show that the U.S. banking system's risk exposure to the most vulnerable EU countries appears to be manageable. U.S. banks' on-balance sheet financial claims vis-á-vis those countries, adjusted for guarantees and collateral, look substantial in absolute terms but are rather small relative to the size of U.S. banks' total financial assets (see the chart below). The exposure to Spain is the biggest, closely followed by Ireland and Italy. Overall, the five countries account for less than 2 percent of U.S. banks' assets.
U.S. exposure to developed Europe as a whole, however, is much higher at $1.2 trillion, so U.S. financial institutions may feel some pain if the European economy slows down markedly. How likely is a marked slowdown? It's difficult to determine, of course, but when asked about the largest risks facing the U.S. economy over the next year, the Blue Chip forecasters put "spillover effects of Europe's debt crisis" at the top of their list.
By Galina Alexeenko, economic policy analyst at the Atlanta Fed
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September 01, 2009
Us and them: Reviewing central bank actions in the financial crisis
With all the focus on the financial crisis in the United States, folks in this country might sometimes lose sight of the fact that this crisis has been global in nature. To provide some perspective on the global dimensions of the crisis, we are providing a few summary indicators of financial sector performance and central bank policy responses in the United States, the United Kingdom, the Euro Area, and Canada. Based on this general review, we surmise that some of the experiences have been remarkably similar, while others appear to be quite different. To pre-empt the question: Why these four regions? The reason is simply that the data were readily available. We encourage readers to use data from other areas, and let us know what you find.
The first chart compares relative changes in monthly stock market price indices for 2005 through the end of August. During the crisis, market participants significantly reduced their exposure to risky assets, which helped push equities lower. All indices peaked in 2007, except Canada, which technically peaked in May 2008. Canada outperformed relative to the others in early 2008 but suffered proportionally similar losses thereafter. The United Kingdom, Euro Area, and Canada bottomed in February 2009 while the United States bottomed in March 2009. The Euro Area to date has experienced the strongest rebound in equities, increasing by almost 40 percent since the trough in February. However, Europe also had the largest peak-to-trough decline, almost 60 percent. Canada and the United States have jumped by about 33 percent since their respective lows in February and March, while U.K. stock prices have risen by about 30 percent since February.
The second chart compares long-term government yields. As the crisis unfolded in late 2007, yields on 10-year U.S. Treasuries sank as global flight to quality helped push yields lower. Yields on U.S., U.K., and Canadian bonds have all moved lower than they were prior to the onset of the crisis. Interestingly, in the Euro Area, prior to the crisis, sovereign yields were at or below bond yields in the other countries but are now slightly above those. In fact, Euro Area yields haven't moved much since the beginning of the crisis in late 2007.
The third chart contrasts monetary policy rates in the four regions. The chart shows that all the central banks lowered rates aggressively, but there are some subtle differences in the timing. For the United Kingdom, Euro Area, and Canada, the bulk of policy rate cuts came after the financial market turmoil accelerated in the fall of 2008, whereas in the United States the majority of the cuts came earlier.
The Fed was the first to lower rates, cutting the fed funds rate by 50 basis points in September 2007 at the onset of the crisis. The Fed continued to lower rates pretty aggressively through April 2008, with a cumulative reduction of 325 basis points. Once the financial turmoil accelerated again in the fall of 2008 the Fed cut rates again by another 200 basis points.
The Bank of Canada's cuts followed a generally similar timing pattern to the Fed but with differences in the relative magnitude of the cuts. In particular, the Bank of Canada rate lowered rates by 150 basis points through April 2008 and then by another 275 basis points since September 2008.
Similarly, the Bank of England cut rates three times in late 2007/early 2008, totaling 75 basis points. But like the Bank of Canada, the bulk of their policy rate cuts didn't come until the increased financial turmoil in the fall of 2008. Between September 2008 and March 2009, the Bank of England cut the policy rate by 450 basis points.
Unlike the other central banks, the European Central Bank (ECB) did not initially adjust policy rates down as the crisis emerged in late 2007. In fact, after holding rates steady for several months it increased its rate from 4 percent to 4.25 percent in July 2008. It started cutting rates in October 2008, and from October 2008 to May 2009 the ECB reduced its refinancing rate by 325 basis points. Of the four regions, the ECB currently has the highest policy rate at 1 percent. For some speculation about the future of monetary policy rates for a broader set of countries, see this recent article from The Economist.
The final chart compares relative changes in the size of balance sheets across the four central banks. The balance sheet changes might be viewed as an indication of the relative aggressiveness of nonstandard policy actions by the central banks, noting that some of the increases can be attributed to quantitative easing monetary policy actions, some to central bank lender-of-last-resort functions, and some to targeted asset purchases.
The sharpest increases in the central bank balance sheets came in the wake of the most intense part of the financial crisis, in the fall of 2008. There had been relatively little balance sheet expansion until the fall 2008. Prior to that, the action was focused mostly on changing the composition of the asset side of the balance sheet rather than increasing its size. The size of both U.S. and U.K. balance sheets has more than doubled since before September 2008, although both are now below their peaks from late 2008. Note that in the case of the Bank of England, quantitative easing didn't begin until March 2009, and the subsequent run-up in the size of the balance sheet is much more significant than in the United States. Prior to that, the increase in the Bank of England balance sheet was associated with (sterilized) expansion of its lending facilities.
In contrast, the Bank of Canada and ECB increased their balance sheets by about 50 percent—much less than in the United Kingdom or United States. By this metric, nonstandard policy actions have been less aggressive in Canada and the Euro Area. Why these differences? This recent Reuters article provides a hypothesis that focuses on institutional differences between the Bank of England and the ECB. In a related piece, this IMF article compares the ECB and the Bank of England nonstandard policy actions.
Note: The Bank of England introduced reforms to its money market operations in May 2006, which changed the way it reports the bank's balance sheet data (see BOE note).
By John Robertson, vice president and senior economist, and Mike Hammill and Courtney Nosal, both economic policy analysts, at the Atlanta Fed
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March 20, 2009
A look at the Bank of England’s balance sheet
The current financial crisis is global in scope, with central banks responding in various ways to mitigate the strains in their respective countries. The Federal Reserve is not the only central bank that has been aggressive in its response. For instance, the Bank of England's (BoE) Monetary Policy Committee, in its March 5 policy statement, explained the details of its new asset purchase program:
"…the Committee agreed that the Bank should, in the first instance, finance £75 billion of asset purchases by the issuance of central bank reserves. The Committee recognised that it might take up to three months to carry out this programme of purchases. Part of that sum would finance the Bank of England's programme of private sector asset purchases through the Asset Purchase Facility, intended to improve the functioning of corporate credit markets. But in order to meet the Committee's objective of total purchases of £75 billion, the Bank would also buy medium- and long-maturity conventional gilts in the secondary market. It is likely that the majority of the overall purchases by value over the next three months will be of gilts."
Thus, the BoE will purchase £75 billion of assets (approximately U.S. $108 billion as March 20 and U.S. $106 billion as of March 5), mostly intermediate-to-longer dated U.K. sovereign debt (or gilts) but also some "investment grade" corporate bonds. Along with this new asset purchase program, to ease strains in credit markets the BoE has previously implemented other efforts, such as purchasing commercial paper, asset-backed securities, and corporate bonds. But these earlier efforts were conducted in such a way that the BoE sterilized its purchases—that is, for every £1 of private assets it purchased, the BoE would issue £1 of its own debt (sterling bills), with the effect being that the money base (bank reserves plus currency in circulation) grew much less than the overall size of the balance sheet.
However, with the new asset purchase program, the BoE is targeting a quantity of U.K. sovereign debt to purchase in an unsterilized manner, hence the key phrase "by the issuance of central bank reserves." As stated, the BoE will be buying gilts, "with the aim of boosting the supply of money and credit and thus raising the rate of growth of nominal spending to a level consistent with meeting the inflation target [2% CPI inflation] in the medium term."
The impact of the BoE's efforts to support private credit markets can be seen in this chart of the size and composition of the BoE's assets:
As the size of the asset side of the BoE's balance sheet grew, so did the liability-side:
Notice that much of the increase in the liabilities has come from "other liabilities" and "short-term open market operations" and not "reserve balances." But with the new asset purchase program, reserve balances will become much larger.
By Laurel Graefe and Andrew Flowers, economic analysts at the Atlanta Fed.
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June 12, 2007
Putting The Money Back In Monetary Policy?
The Wall Street Journal's Joellen Perry reports (page A8 in the print edition) on the latest debate within the European Central Bank:
With euro-zone interest rates near a six-year high, European Central Bank policy makers are clashing over the role of the swollen supply of money in pushing up prices.
That rare break in the bank's public facade of unity suggests policy makers are divided about how high to push interest rates in the 13-nation currency bloc, and it could rekindle a global debate on the merits of monitoring money supply...
Years of low interest rates have fueled a global liquidity glut that has inflation-wary central bankers world-wide paying attention to money-supply data. The ECB, as the only major central bank to give money-supply growth an official role in its decision-making, has led the charge. But other policy makers, including at the Bank of England and Sweden's Riksbank, have also cited strong money-supply growth as a reason for recent interest-rate rises.
Actually, Claus Vistesen was thinking about this last week, while I was in Frankfurt attending a joint conference on Monetary Strategy: Old issues and new challenges, jointly sponsored by the Deutsche Bundesbank and the Federal Reserve Bank of Cleveland. The question of whether or not central bankers ought pay attention to money, and talk about it when they do, did come up. Gunter Beck and Volcker Wieland, both from the Goethe University Frankfurt (and the latter formerly of the Federal Reserve Board), offered up a theoretical argument for why the money-guys in the ECB might be on to something:
... we develop a justification for including money in the interest rate rule by allowing for imperfect knowledge regarding unobservables such as potential output and equilibrium interest rates. We formulate a novel characterization of ECB-style monetary cross-checking and show that it can generate substantial stabilization benefits in the event of persistent policy misperceptions regarding potential output.
... We assume that the central bank checks regularly whether a filtered money growth series adjusted for output and velocity trends averages around the inflation target. If the central bank obtains successive signals of a sustained deviation of inflation from target it adjusts interest rates accordingly.
Our simulations indicate that persistent policy misperceptions regarding potential output induce a policy bias that translates into persistent deviations of inflation and money growth from target. In this case, our “two-pillar” policy rule may effectively overturn the policy bias. Cross-checking relies on filtered series of actual money and output growth without requiring estimates of potential output. Indirectly, however, it helps the central bank to learn the proper level of interest rates.
Some of the conference participants noted that there are lots of alternative (and established) statistical techniques for forecasting in the face of uncertainties about concepts such as potential output and the equilibrium real interest rate, but another of the conference papers -- from the Bundesbank's Martin Scharnagl and Christian Schumacher -- suggested that Beck and Wieland may just be on to something when they say the ECB money-guys may just be on to something:
This paper addresses the relative importance of monetary indicators for forecasting inflation in the euro area. The analysis is carried out in a Bayesian framework that explicitly considers model uncertainty with potentially many explanatory variables...
The empirical results show that money is an integral part of the forecasting model... The key finding of the paper is is that the majority of models include both monetary and non-monetary indicators.
To paraphrase, when it comes to short-run forecasts, the kitchen sink works best. But the result that got my attention was Scharnagl and Schumacher's finding that, in their experiments, the trend in the money supply is the only factor that appears useful in forecasting inflation once you get out beyond about 6 quarters.
That may surprise you, but it probably shouldn't. The Scharnagl and Schumacher study is on the technical side, but some years ago economists George McCandless and Warren Weber offered up some evidence which was pretty easy to grasp:
That's a graph of the relationship between average money growth (measured by M2) and average inflation for a large cross-section of countries, over the period from 1960 through 1990. If you are an old hand on this topic, you probably remember that it was around 1990 that both the ECB and the Federal Reserve lost confidence in the money measures they were tracking. The ECB responded by moving from a narrow measure of money to the very broad M3 concept. The Federal Reserve responded by more-or-less abandoning monetary measures all together.
OK, let's take a look at the McCandless and Weber picture post-1990:
Hmm. The Wall Street Journal article correctly notes that there is still a great deal of skepticism about the usefulness of monetary measures in formulating monetary policy:
The U.S. Federal Reserve is among the doubters. Fed Chairman Ben Bernanke said in November that a "heavy reliance" on money-supply data as a predictor of U.S. inflation was "unwise."
I don't think either the Beck-Wieland or Scharnagl-Schumacher work contradicts that skepticism about "heavy reliance." But maybe money deserves just a little more love on this side of the Atlantic than it currently gets?
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» Transparency and the ECB from Economist's View
Francesco Giavazzi argues that monetary policy in Europe could be greatly improved with increased transparency at the European Central Bank: Sarkozy and the ECB: Right intuition, wrong target, by Francesco Giavazzi, VoxEU: During his electoral campaign... [Read More]
Tracked on Jun 18, 2007 4:27:30 PM
May 26, 2007
Why Not Just Ask?
I'm home at last from the Conference on Price Measurement for Monetary Policy that has absorbed my attention over the past couple of days, but I have one more post on the topic left in me, not least because the topic of the last several papers -- the measurement of inflation expectations gleaned from survey data -- is one in which I have a particular interest. As far as I know, the review of the ECB Survey Professional Forecasters (SPF) (by authors from the European Central Bank too numerous to mention here) is the first large-scale overview of its kind, and thorough it is. Among the copious information is this, which I found particularly interesting:
... average long-term expected inflation has remained quite stable since the beginning of the survey. On average, it stood at 1.88% with a standard deviation of ±0.04 percentage point. The average long-term inflation expectation was 1.9% at the start of Stage III of EMU in 1999. It declined to 1.8% in 2000 and then shifted upwards to stand at 1.9% again at the end of 2002. Since then, it has remained broadly stable at below, but close to, 2%, confirming the stability of SPF long-term inflation expectations.
The picture, proving the point:
Contrast this with a fascinating observation from the National Bank of Belgium's Luc Aucremanne, Marianne Collin and Thomas Stragier, contrasting actual inflation with perceived inflation based on surveys of consumers:
While there is clearly no doubt about the accuracy of official inflation measures in the euro area during the recent period, there is plenty of anecdotic evidence that since 2002 consumers have tended to perceive that inflation is high, while in reality it was relatively low, albeit slightly above the quantified definition of price stability for the euro area. Apparently a perception gap has grown in the euro area since the euro cash changeover in January 2002.
The pictures are striking:
The kicker is that no such divergence in perceptions occurred in comparable European countries that did not adopt the euro:
I'm not sure what to make of that, other than that there is an awful lot we don't know about what consumers are telling us when they answer these survey questions -- an observation that is confirmed in a review of survey responses from the Czech Republic, Hungary, Poland, and Slovakia by Ryszard Kokoszczynski, Tomasz Lyziak, and Ewa Stanislawska (of the National Bank of Poland).
Until we more clearly understand household responses to the questions we ask, it appears that surveys of professional forecasters represent the best available source for obtaining direct information about inflation expectations. There is growing literature on how to get the most out of these surveys, and I'll close with a word of praise for the paper "What Can Four Decades of Probabilistic Inflation Forecasts Tell Us About Inflation Risks?" by the ECB's Juan Angel Garcia and Andres Manzanares. As the title of the paper makes clear, the idea is to characterize, for example, whether survey respondents see the balance of inflation risks as weighted to the upside or downside. The literature to which the Garcia-Manzanares paper belongs tends to the technical, but it is well worth a look if you have a stake in knowing which way the forecaster winds are blowing.
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Tracked on Jun 20, 2007 3:32:33 AM
May 07, 2007
On Cake, And Eating It Too
"'It will never be possible to stress enough the evil that the 35-hour week has done to our country. How can we retain this mad idea that by working less, we will produce more wealth and create jobs?"
... and tax cuts are in:
"We've got the highest taxes in Europe. France's problem is we're paying too much tax."
The cause for Turkish membership in EU wasn't much helped ...
"I want an integrated Europe, in other words, a Europe that has borders ... Turkey is in Asia Minor."
... and immigration control is front and center:
"Who can't see that there's a clear link between the uncontrolled immigration of 30 or 40 years and the social explosion on our housing estates?"
The immigration issue is a complicated one, and I have no business commenting a sovereign nation's assessment of how to best deal with the social consequences of open borders. But this story, from the Wall Street Journal (page A2 in the print edition), provides an interesting juxtaposition:
The quality of life for some 80 million graying baby boomers in the U.S. may depend in large part on the fortunes of another high-profile demographic group: millions of mostly Hispanic immigrants and their children.
With a major part of the nation's population entering its retirement years and birth rates falling domestically, the shortfall in the work force will be filled by immigrants and their offspring, experts say. How that group fares economically in the years ahead could have a big impact on everything from the kind of medical services baby boomers receive to the prices they can get for their homes.
The article does not make a French connection, but one is not hard to conjure up. A few years back, a Rand Corporation study had this to say:
The history of French population change is atypical; secular fertility decline began one century before the rest of the West. As a consequence, France had the oldest population in the world over the entire period of 1850–1950. The baby boom after the Second World War created a temporary increase in the number of births, but thereafter the fertility decline resumed. With current below-replacement fertility and increased life expectancy, population ageing is expected to reach new heights...
Family policies in France are a complicated mix, as the Rand article makes clear, and recent efforts at promoting fertility among native French citizens appear to have met with some success. But this bottom line judgment, from the UN, remains relevant:
In most developed countries, the decline in fertility and the increase in longevity has raised three concerns for the future: the decrease in the supply of labor, the socioeconomic implications of population aging, and the long term prospect of population decline and demise...
On the medium run, the next ten years or so, the labor market is the main focus of concern. The reference system comprises here the set of supply and demand variables that determine the employment equilibrium. The impact of fertility and mortality changes is for that purpose at this time horizon very limited. Conversely, international migration could play a decisive role, as well as other socioeconomic variables.
For the long run, - from 2020 to the population projections horizon 2040-2050- structural imbalances of the age distributions are things to worry about.
Economists had predicted that investors would greet Mr Sarkozy’s election with enthusiasm, in anticipation of tax cuts, labour reform and debt-reduction measures.
In the long run, that last goal will require that immigration reforms be chosen wisely.
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May 02, 2007
Mervyn King Reflects
The Financial Times records some thoughts from Bank of England Governor Mervyn King, reflecting on the Bank's performance over the past ten years:
He regards one of the Bank’s biggest achievements over the past 10 years as grasping early on the scale and significance of migrant labour from eastern Europe after the enlargement of the European Union in 2002.
“It’s our equivalent of [former US Federal Reserve chairman] Alan Greenspan [realising] the faster growth of output in the late 1990s was the result of faster productivity growth.”
He continued: “That was an absolutely correct judgment at the time and that’s what we have to do with every variable that we look at, work out why it’s growing faster or slower than it was before and not to use some rather mindless regression.”
What were those insights of which King is so proud? From the Telegraph:
Immigration from eastern Europe has helped keep inflation - and therefore interest rates - low, the Governor of the Bank of England Mervyn King said last night.
Speaking to business leaders at a dinner outside Bradford, Mr King praised globalisation as a way of increasing productivity and transferring new ideas, goods and services across borders.
In particular, he said immigration had reduced wage inflation in Britain: "If the increased demand for labour generates its own supply in the form of migrant labour then the link between demand and prices is broken, or at least altered. Indeed, in an economy that can call on unlimited supplies of migrant labour, the concept of the output gap is meaningless."
The output gap is a measure used by economists to see how much spare capacity is left in an economy.
"Increasing productivity and transferring new ideas" is certainly equivalent to the Greenspan insight. But on the output gap bit, a better comparison is to Federal Reserve Bank of Dallas President Richard Fisher:
One key capacity factor is the labor pool. There is a shibboleth known as the Phillips curve, which posits that beyond a certain point too much employment ignites demand for greater pay, with eventual inflationary consequences for the entire economy...
How can economists quantify with such precision what the U.S. can produce with existing labor and capital when we don’t know the full extent of the global labor pool we can access? Or the totality of the financial and intellectual capital that can be drawn on to produce what we produce?
As long as we are able to hold back the devil of protectionism and keep open international capital markets and remain an open economy, how can we calculate an “output gap” without knowing the present capacity of, say, the Chinese and Indian economies? How can we fashion a Phillips curve without imputing the behavioral patterns of foreign labor pools? How can we formulate a regression analysis to capture what competition from all these new sources does to incentivize American management?
Until we are able to do so, we can only surmise what globalization does to the gearing of the U.S. economy, and we must continue driving monetary policy by qualitative assessment as we work to perfect our quantitative tool kit. At least that is my view.
And, apparently, Governor King's view as well. Back to the FT:
“The secret of good policy is to try and think through what are the economics of the shocks hitting the economy at present,” he says. “That in a nutshell is my philosophy of how you should do policy. Don’t rely on regressions from the past.”
OK, but I'm not sure I would recommend entirely forgetting those recessions from the past either, lest we find ourselves repeating their lessons.
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February 24, 2007
The Euro Vs. The Dollar
Although I've not written much about the topic lately, I have been monitoring the debate of the last several months about the rise of the euro, and the related question of whether it will eventually emerge as the world's dominant international money. The discussion has been prompted in part by the fact that euro appreciated by about 11 percent from December 2005 to December 2006, but also by some really splashy news: The observation that the value of euro notes in circulation has surpassed the value of dollar notes, the reported desire of oil-producing countries to diversify their foreign-exchange reserves, and the fact that euro-denominated debt has become a larger share of the global cross-border total than dollar-denominated debt. Yesterday Brad Setser published some ruminations about whether the Japanese yen can ever be the "un-dollar", but the reality is that the euro remains the only real contender for the foreseeable future.
A couple of pictures (constructed by my colleague Owen Humpage) helps to put things in perspective. To begin with, international currency reserves are still dollar dominated:
There are definitely some problems with those statistics -- see, for example, the picture provided by Brad Setser, provided by Menzie Chinn -- but here is another relevant fact: The overwhelming share of foreign exchange transactions involve dollars:
It seems pretty clear that most of the euro activity is still taking place on the European stage. That could change -- there is an interesting discussion about the expanding importance of the export sector being conducted at Eurointelligence and at Eurozone Watch -- but my guess is that the "tipping point" for the euro depends critically on whether the eurozone ultimately expands.
As I have noted in the past, the research of Menzie Chinn and Jeffrey Frankel suggests that the wildcard involves the UK's designs on the euro. But the incorporation of the so-called "accession countries" is at issue as well. For that reason, this, from the Financial Times, got my attention:
On Monday Standard & Poor’s lowered the outlook for Latvia’s long-term sovereign debt from stable to negative. The country has a huge current account deficit, accelerating inflation and loose monetary policy, just like Thailand in 1997. And, as in Asia a decade ago, the symptoms are not limited to one country. As growth has accelerated in the European Union’s 10 newest central and eastern members, it has become unbalanced, propelled by consumers rather than exports. The results are predictable – worsening trade imbalances, mounting inflation and wage pressures. Only Poland and the Czech Republic currently meet the inflation requirement for euro membership, while current account deficits in six of the EU-10 hover near or beyond 10 per cent of gross domestic product. Meanwhile, credit is expanding dramatically – at more than 50 per cent year-on-year in Latvia, Lithuania and Romania, according to Danske Bank.
If the EU were to fracture, the natural fault-line would be the edge of the euro zone, as Toomas Hendrik Ilves, Estonia ’s thoughtful president, has observed...
The common currency includes most of old Europe, but excludes most of the new democracies (including his). What would happen to the outsiders? It would be nice to think, as a worst-case scenario, that the single market would hang together, and that the baker's dozen of countries outside the euro zone would at least remain part of this thriving free-trade area...
Probably, however, the unraveling would go further. The EU already finds it a huge effort to make the Poles, for example, abide by European competition law. Without a seat at the top table in Brussels, no Polish government would allow foreigners to claim full national treatment, especially when it came to buying the country’s big companies. With that, the single market would unravel too.
That all may be a bit alarmist -- the worst-case scenario is important to think about, but it rarely happens. The point is that, despite the challenges that undeniably confront policy makers in the United States, there are equal, if not more daunting, challenges elsewhere. I have my doubts that the "exorbitant privilege" of being the world's dominant currency is likely to pass from the dollar any time soon.
UPDATE: Export activity in Germany (and Japan) is also on the mind of Edward Hugh, at Bonobo Land.
UPDATE II: Claus Vistesen uncovers an article from the Financial Times suggesting that central bankers are chasing yield by by taking on more risk, as well as by diversifying the currencies in their reserve portfolios. My sense is that this sort of motivation drives "investment" decisions at the margin, but that core portfolio choices are still driven by "fundamentals" related to trade flows, financial market activity, and internal exchange rate policies. But as the FT article notes, central bankers are "a secretive bunch," so there is a lot we -- or at least I -- don't know.
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