Consequences of New Macroeconomic Insights for Economic Policy and Economic Performance in the Europe
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Idea of this talk
• Discuss some new economic insights • Discuss potential impact on economic policy • Discuss relevance for economic growth in Europe
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Four Areas of Macroeconomic Research
1. (Super) hysteresis & secular stagnation 2. Causes of the Euro crisis 3. Keynesian economics & fiscal policy 4. Monetary policy
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(Super) hysteresis & Secular stagnation
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Growth before & after recessions Portugal log real GDP
Source: Blanchard, Cerutti, and Summers (2015) 5
Hysteresis versus Secular Stagnation Hysteresis: • Recessions, especially unemployment, has permanent damage • (Regular) hysteresis: pemananent level effects • Super hysteresis: growth rate affected • Many stories: Loss of human capital, loss of networks
Secular stagnation: • More than just a long recession or period with low growth • Some disequilibrium that does not automatically disappear 6
Secular Stagnation Example • Young: • Work • Borrow funds • Middle-aged: • Work & run firms • Save to invest • Save by lending to the young • Old: • Eat their savings 7
Secular Stagnation Example • Suppose supply of savings middle-aged ↑ supply of savings >> demand for funds
• Standard mechanism: ⇒ interest rate ↓ ⇒ demand for funds ↑
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Secular Stagnation Example • Standard mechanism less likely to happen if need for funds not very sensitive to interest rate and/or equilibrium real interest rate low or negative • Standard mechanism impossible if equilibrium real rate < - inflation ⇒ negative nominal rate
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Secular Stagnation Example
• If savings middle-aged ↑ ⇒ less demand for consumption goods • If standard mechanism does not work ⇒ reduction in demand for goods not compensated ⇒ middle-aged sell & produce less ⇒ middle-aged have less income ⇒ actual outcome attained by middle-aged not saving more
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Consequences for Economic Policy Fiscal policy: • Really good time for • Government investment: infrastructure, education, health care • Structural reforms
Monetary policy:
• Increase inflation target
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Consequences for growth in Europe • Increase in government investments highly unlikely • Increase in inflation targets unlikely • ⇒ secular stagnation remains a concern • ⇒ pessimistic outlook
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Causes of the Euro Crisis
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Causes of the Eurozone crisis Not irresponsible sovereign debt accumulation! •
Except Greece
1. Large current-account imbalances 2. Large/unhealthy financial sector 3. No governance structure to detect risk and deal with crisis
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Jan-1990 Dec-1990 Nov-1991 Oct-1992 Sep-1993 Aug-1994 Jul-1995 Jun-1996 May-1997 Apr-1998 Mar-1999 Feb-2000 Jan-2001 Dec-2001 Nov-2002 Oct-2003 Sep-2004 Aug-2005 Jul-2006 Jun-2007
10 yr gov't bond yields (%) 16 14 12 10 8 6 4 2 0
Greece Ireland Italy Spain Portugal Austria Belgium France Germany Luxembourg Netherlands Finland
Eurozone sovereign debt yield spreads vanished, ⋅⋅⋅ 15
Cumulative current-account balance 1999-2007 (% of own GDP)
FANG countries
GIPSI countries Greece
-84%
Finland
+61%
Ireland
-21%
Austria
+16%
Portugal
-96%
Netherlands
+48%
Spain
-60%
Germany
+27%
Italy
-8%
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0 Jan-1990 Oct-1990 Jul-1991 Apr-1992 Jan-1993 Oct-1993 Jul-1994 Apr-1995 Jan-1996 Oct-1996 Jul-1997 Apr-1998 Jan-1999 Oct-1999 Jul-2000 Apr-2001 Jan-2002 Oct-2002 Jul-2003 Apr-2004 Jan-2005 Oct-2005 Jul-2006 Apr-2007 Jan-2008 Oct-2008 Jul-2009 Apr-2010 Jan-2011 Oct-2011 Jul-2012 Apr-2013 Jan-2014 Oct-2014 Jul-2015
10 yr gov't bond yields (%) 30 Greece
25 Ireland
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15 Italy
10 Spain
5 Portugal
Germany
But spreads reappeared! 17
Eurozone Imbalances Large current-account imbalances •
⇒ Periphery financed deficits by borrowing from core countries
•
Capital flows went to non-tradable sectors
•
When confidence plummeted ⇒ foreign lending stopped = “sudden stop”
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Eurozone Financial Sector • Large financial sector; in some countries very large • Unhealthy balance sheets: low equity and bad assets • Very exposed to own government sector
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Large financial sector
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Governance Problems
• Periphery countries did not have the usual lender of last resort: • Central banks can guarantee that sovereign debt can be rolled over; ECB not allowed to do this ⇒ Euro-denominated borrowing similar to borrowing in foreign currency
• Stability and Growth Pact did not work • Eurozone banks were overleveraged, but oversight left to individual countries • No joint response mechanism ⇒ ad hoc crisis management
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New Theoretical Insights?
The are several, but many macroeconomists stress old wisdom that the Eurozone is not an optimal currency union
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Consequences for Economic Policy 1. Banking union 2. Euro exits? 3. Substantial financial reform? 4. Fiscal union? 5. Euro bonds?
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Consequences for Eurozone growth?
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Lots of uncertainty!
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No convincing structural improvements any time soon
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⇒ at best low growth
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Keynesian Economics & Fiscal Policy
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New & Old Keynesian Macroeconomics New Keynesian paradigm: • All about sticky goods prices
Old Keynesian paradigm: • Firms do not hire because of concerns they cannot sell & consumers do not buy because of job concerns
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“Old” Keynesian Models
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Fiscal policy in Keynesian Models Traditional view about “b”: • • • •
High b: Poor people that cannot borrow: C depends on current income (hand-to-mouth consumers) Low b: Rich people: C depends on life-time income Rich people more important for aggregate ⇒ b not that high ⇒ fiscal policy not very effective
New evidence: • •
Empirical: There are many rich hand-to-mouth consumers Theoretical: If central bank’s policy interest rate ≈ 0 ⇒ fiscal policy can be effective even if there are not many hand-tomouth consumers 28
Consequences for Economic Policy • Keynesian fiscal policy has become very popular again among academics • What about politicians?
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Financial Crisis & European fiscal policy Countercyclical tightening
Change in cyclically-adjusted primary deficit (p.p.)
3 Pro-
cyclical tightening
2012
2013
2011
2104
0
2007
2010 2009
2008
Countercyclical -3 expansion
-5
2006
Pro-cyclical expansion
0
5
Output gap (% of potential GDP)
Source: Baldwin and Giavazzi (2015)
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Consequences for growth in Europe • Austerity popular among European politicians • ⇒ pessimistic short-term outlook for economic growth
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Monetary Policy
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Monetary Policy During Financial Crisis
• Flattening of Phillips curve: • Large unemployment fluctuations, but • Inflation remained relatively stable
• Very expansionary monetary policy • Policy interest rates close to zero • Large asset purchases: Quantitative easing • Forward guidance
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Crisis and Deflationary Pressure?
Source: Blanchard, Cerutti, and Summers (2015) 34
Theoretical developments • How to stimulate an economy when policy interest rate is at zero lower bound • Forward guidance can be very powerful when 1. policy interest rate is at zero-lower bound and 2. central bank commits now to future policy that will be wrong policy in the future
• Forward guidance can also be helpful in better explaining central bank’s views & intentions • Theoretical support for QE based on old-fashioned models 35
Consequences for Economic Policy • Flattening Phillips curve: Target real activity not inflation? • Structural changes to allow more easily for negative interest rates? • Increase the target inflation rate? • Wörgl Experiment 1932-33
• Will monetary policy be more responsive to signals of financial risk such as increased leverage
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Consequences for growth in Europe 1. More experienced central bankers & new tools 2. Future monetary policy uncertain • Unclear what set of policy tools will be used in practice • Unclear how and when central banks asset positions will be unwinded • Unclear how prudential policy will interact with traditional monetary policy #1 is probably good for economic growth #2 is probably good not for economic growth
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