Euro zone may struggle with its own Lost Decade
Additional Reporting by Andy Bruce and polling by Rahul Karunakar and Sumanta Dey.
As Europe’s crisis drags on, the prospect of a Japanese-style lost decade of economic malaise is becoming increasingly real, according to a new poll. Half of the bond strategists and economists surveyed by Reuters are now expecting just such an outcome.
Many market participants have dismissed the fall of two-year German bond yields below their Japanese counterparts as being merely a result of a crisis-fueled flight to quality bid. Two-year German yields are now close to zero, offering returns of only 0.02 percent. By contrast, equivalent Japanese bonds are yielding 0.11 percent.
But a significant portion of analysts in a Reuters poll see something more sinister in the rapid narrowing of the premium investors require to hold German debt over Japanese bonds. One half of those polled – 12 out of 24 – said it is likely the euro zone is close to entering a period of prolonged low or no growth and inflation and low interest rates, with the other half saying it was unlikely.
According to Stephen Lewis, chief economist at Monument Securities:
I don’t really see an early end to the financial crisis in the euro zone. I think it’s very unlikely that Germany and the other countries will see eye to eye in the course of this year. That’s going to keep the euro zone economy looking very weak for the next several quarters.
Europe’s economy stagnated in the first quarter of 2012 and is expected to shrink 0.4 percent this year, according to another recent Reuters poll. Data on Thursday certainly pointed in that direction, suggesting even wealthier countries like France and Germany are also starting to feel the pinch.
Israel’s new-found jobless
Following on from Nigeria’s rebasing of its GDP numbers, giving it a huge growth boost on paper, it is Israel’s turn to tinker with the numbers. This time, though, the end result was not positive.
The country’s Central Bureau of Statistics said on Monday that the first-quarter jobless rate was 6.7 percent. This a good 1.3 percentage points higher than the announced fourth-quarter figure.
It does not, however, signal a sudden cull of workers across Israel. It is the result, rather, of Israel adopting a new way of counting employment designed to bring it in line with the way leading Western economies do it. So the equivalent fourth-quarter number would have been 6. 8 percent, slightly higher.
There were close to 40 changes made to the survey, according to our correspondent Steven Scheer, from adding 100 more cities and towns to including soldiers. (The later, being 100 percent employed, should have lowered the rate, but apparently not enough).
Government and monetary officials were quick to point out that the unemployment rate is still pretty good compared with say 7.4 percent for the OECD as a whole. The finance ministry also said the increase was due to the new survey showing a higher employment participation..
Nonetheless, it has rather undermined some government claims that Israel is weathering the global economic storm far better than most.
And then, of course, if the new counting measure is better and more accurate, the number of jobless did jump above what was thought – only not just in the past quarter.
Bernanke: U.S. is not Japan, and I have not changed my mind
Of all the questions Federal Reserve Chairman Ben Bernanke was asked during his press conference on Wednesday, one appeared to pique his interest in particular: Was he being less aggressive as central bank chairman than the advice he dished out to Japan as an academic in the 1990s would prescribe?
It was the second half of the question asked by Binyamin Applebaum and yet the chairman was eager to get right to it: “Let me tackle that second part first,” he began.
Applebaum may have been channeling the Nobel-winning economist Paul Krugman, a Princeton colleague of Bernanke’s and critic of Fed policy, who recently argued the Fed chief was being inconsistent and overly cautious.
Bernanke argued that the Fed has done a lot already to support growth and bring down unemployment. Actively aiming for higher inflation with additional use of unconventional tools would risk the central bank’s long-term credibility. Here is his answer in full:
So there’s this view circulating that the views I expressed about 15 years ago on the Bank of Japan are somehow inconsistent with our current policies. That is absolutely incorrect. My views and our policies today are completely consistent with the views that I held at that time.
I made two points at that time to the Bank of Japan. The first was that I believe that a determined central bank could and should work to eliminate deflation – that is, falling prices. The second point that I made was that when short-term interest rates hit zero, the tools of a central bank are no longer – are not exhausted. There are still other things that the central bank can do to create additional accommodation.
Now, looking at the current situation in the United States, we are not in deflation. When deflation became a significant risk in late 2010, or at least a modest risk in late 2010, we used additional balance sheet tools to help return inflation close to the 2 percent target. Likewise, we have been aggressive and creative in using non-federal-funds-rate-centered tools to achieve additional accommodation for the U.S. economy.
So the very critical difference between the Japanese situation 15 years ago and the U.S. situation today is that Japan was in deflation. And, clearly, when you’re in deflation, and in recession, then both sides of your mandate, so to speak, are demanding additional accommodation. In this case, we are not in deflation. We have an inflation rate that’s close to our objective.
Now, why don’t we do more? Well, first I would again reiterate that we are doing a great deal. The policy is extraordinarily accommodative. We – and I won’t go through the list again, but you know all the things that we have done to try to provide support to the economy. I guess the question is, does it make sense to actively seek a higher inflation rate in order to achieve a slightly increased reduction – a slightly increased pace of reduction in the unemployment rate?
The view of the committee is that that would be very reckless. We have – we, the Federal Reserve, have spent 30 years building up credibility for low and stable inflation, which has proved extremely valuable in that we’ve been able to take strong accommodative actions in the last four, five years to support the economy without leading to an unanchoring of inflation expectations or a destabilization of inflation. To risk that asset for what I think would be quite tentative and perhaps doubtful gains on the real side would be, I think, an unwise thing to do.
Never mind the pain, feel the austerity
Austerity in the euro zone seems to be working — at least as far as the headline, dry, soulless numbers of budget balancing are concerned. Bailed out Greece and Ireland have reported substantial improvements in last year’s profligacy performance. Spain, while going in the wrong direction, at least has the satisfaction of being told it is not telling fibs.
We will get to the smoke and mirrors in a bit.
First Greece, the euro zone’s poster child for budget ill-discipline. The 2011 budget deficit to GDP ratio – basically the annual overspend — came in at 9.1 percent. This may seem like a lot given the EU target is 3 percent, but it was down from 10.3 percent a year earlier and from 15.6 percent the year before that. Furthermore, if you take out all the debt repayments costs that Athens has to make , you end up with only 2.4 percent (although in truth that is like pretending you don’t have a mortgage).
In Ireland, the craic was all about trouncing expectations. The deficit to GDP ratio for 2011 came in at 9.4 percent, which compared with an original 10.6 percent target and even a revised target just last December of 10. 1 percent. Everything is on track, Dublin reckons, to meet this year’s 8.6 percent.
Now, those not wanting their party pooped, please look away.
The official figures suggest that Greece’s improvement is almost entirely down to increased revenues. Government spending as a percentage of GDP last year was 50.1 percent, barely changed from a year early and only a tad down from 2008. And this comes after a number of years of painful austerity that has helped keep Greece in recession for more than four years — it is into its fifth now, staring at a 4.8 percent 2012 contraction — and that has pushed more than a fifth of the country out of work. Greece’s debt (ie accumulated deficits) as a proportion of GDP last year was 42.3 percentage points higher than in 2008.
Ireland, in the meantime, was enjoying its deficit improvement (still the worst in the euro zone) by finessing away one-off capitalisations into its banks that were worth some 3.7 percent of GDP. Including those and some others, the deficit last year was 13.1 percent. This comes after Ireland has made budgetary adjustments totalling 25.4 billion euros since 2008 — the equivalent to 16 percent of it 2011 GDP — and has had to hike taxes and cut spending by 8.6 billion euros between 2013 and 2015, i.e. another 5 percent of GDP. It is back in recession and seeing its exports hit by the troubles is main trading partners in the European Union are having.
The Law of Diminishing Greeks
The Law of Diminishing Returns states that a continuing push towards a given goal tends to decline in effectiveness after a certain amount of effort has been expended. If this weren’t the case, Usain Bolt would be able to run the mile in less than 2-1/2 minutes.
From an economic standpoint, this law now seems to be fully in force in Greece. The latest jobs figures from the twice-bailed out euro zone country paint a bleak numerical picture of the impact of unrelenting austerity in ordinary Greeks, regardless of whether it was self-inflicted or not. To wit:
More than one in five Greeks is unemployed.
There are more young people without a job than with one.
The record 1.08 million people without work in January was a 47 percent tumble in a year.
Putting aside for the moment the question of what such a condition means for political dissent, there is now the issue of whether any of this austerity-fueled pain is actually helping the Greek economy.
Austerity mixed with the inability of euro-tied Greece to devalue its currency means Greece is now in its fifth year of recession. As for job-creating small and medium -sized businesses, the latest projections are that more than a net 130,000 of them will have shut down over two years by the time 2012 is over.
The biggest example of the Law of Diminishing returns, however, is the impact all this is having on what ails Greece in the first place — its budget.
Unemployed people offer no revenue to the government in terms of income tax and far less in sales tax than they would if they were working.
A worker is a terrible thing to waste
How bad is the U.S. employment situation? The Labor Department’s tally for March, which showed only 120,000 new jobs were created, raised doubts about the sustainability of a recent pick up in job growth. But to get a broader sense of what things are really like it helps to put things in a longer-term perspective.
Even with the 3.6 million new jobs created during the recovery, some 5 million more are needed just to make up for all of the jobs that were lost during the Great Recession. At March’s pace, it would take nearly four more years to get there – and that’s not accounting for population growth.
If job growth remains at tepid clip of around 150,000 a month, it would take five years for the jobless rate, which registered 8.2 percent in March, to fall to 6 percent, according to Atlanta Federal Reserve Bank economist Julie Hotchkiss.
Dean Baker at the Center for Economic and Policy Research says that, while the March figure very likely reflects some payback for the stronger activity seen during the earlier months of an unusually warm winter, the long term outlook remains bleak.
The weaker job growth in the March data is primarily an artifact of the weather. However the 212,000 average job gain over the last three months is not especially strong. It implies a return to full employment some time in 2019.
Spain: ¿Cómo se dice “contagion”?
It was not a good day for Spain.
The euro zone’s fourth largest economy had to pay dearer to borrow through medium-term bonds, a sign that concerns over the country´s fiscal problems was curbing appetite for its debt. It sold 2.6 billion euros of 2015, 2016 and 2020 paper – at the low end of the target range.
In contrast, Portugal’s 1 billion euros sale of 18-month treasury bills was a successful test of market appetite for the longest-dated debt since it took an international bailout. Appetite for short-dated paper has been especially supported by the one trillion euros of cheap three-year European Central Bank funding injected into the financial system since December.
The problem is that Spain is the latest country to come into the firing line of the euro zone debt crisis. This week’s tough budget was not enough to calm investor nerves and many fear too much austerity could choke an already struggling economy where unemployment rose to a staggering 22.9 percent in the fourth quarter of 2011 – the highest in the European Union. Meanwhile, the government expects Spain’s public debt to jump in 2012 to its highest since at least 1990.
And although Spain has already sold around 46 percent of this year’s planned issuance of long-term debt and therefore is in a favourable funding position compared to its peers, analysts worry it could become the next source of euro zone contagion. In the secondary market, yields on 10-year Spanish government bonds rose to their highest since January at 5.72 percent after the auction.
DZ Bank rate strategist Michael Leister says:
It was only a lukewarm auction. This shows that the LTRO (ECB’s long-term refinancing operation) effect is losing momentum and that Spain is having a much more difficult time.
Bernanke’s jobs pivot
Jason Lange contributed to this post
Fed Chairman Ben Bernanke made no direct references to the outlook for monetary policy in a speech to the National Association for Business Economics on Monday. But the message from his heavy focus on a weak labor market was pretty clear: The Fed is not considering tightening policy in the near future and stands ready to do more if growth doesn’t pick up steam this year. Ironically, Bernanke’s pessimism cheered the markets – by signaling that another round of stimulus is not off the table.
Andrew Wilkinson at Miller Tabak captured Bernanke’s feat for the day:
It ain’t what you say it’s the way that you say it – at least that’s what Chairman Bernanke found out on Monday by not mentioning further quantitative easing.
After its last two meetings, the Fed said it would likely keep rates near zero at least through late 2014. But upbeat economic signs, including solid employment growth, have led investors to bet on a move as early as the middle of next year. Bernanke’s speech appeared aimed at pushing back against those expectations.
Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi, reacted to the speech on the sidelines of the NABE conference.
Reading between the lines, it sounds like he’s pushing the ball forward towards having a discussion about doing more.
from Lawrence Summers:
It’s too soon to return to normal policies
Economic forecasters divide into two groups: those who cannot know the future but think they can, and those who recognize their inability to know the future. Shifts in the economy are rarely forecast and often not fully recognized until they have been under way for some time. So judgments about the U.S. economy have to be tentative. What can be said is that for the first time in five years a resumption of growth significantly above the economy's potential now appears as a substantial possibility. Put differently, after years when the risks to the consensus modest-growth forecast were to the downside, they are now very much two-sided.
As winter turned to spring in 2010 and 2011, many observers thought they detected evidence that the economy had decisively turned, only to be disappointed a few months later. A variety of considerations suggest that this time may be different. Employment growth has been running well ahead of population growth. The stock market level is higher and its expected volatility lower than at any time since the crisis began in 2007, suggesting that the uncertainty hanging over business has declined. Consumers who have been deferring purchases of cars and other durable goods have created pent-up demand. The housing market seems to be stabilizing. For years now, the rate of family formation has been way below normal as young people moved in with their parents. At some point they will set out on their own, creating a virtuous circle of a stronger housing market, more family formation and demand, and further improvement in housing conditions. Innovation around mobile information technology, social networking and newly discovered oil and natural gas is likely, assuming appropriate regulatory policies, to drive significant investment and job creation.
True, the risks of high oil prices, further problems in Europe, and financial fallout from anxiety about future deficits remain salient. However, unlike in 2010 and 2011, it is probable that these risks are already priced into markets and factored into outlooks for consumer and business spending. There has already been a significant escalation in oil prices. The European situation is hardly resolved but is unlikely to deteriorate as much in the next months as it did last year. And market participants report great alarm about the deficit situation. So it would not take great news in any of these areas for them to actually contribute to upward revisions in current forecasts.
What are the implications for macroeconomic policy? Such recovery as we are enjoying is less a reflection of the natural resilience of the American economy than of the extraordinary steps that both fiscal and monetary policymakers have taken to offset private-sector deleveraging -- a process that is far from complete. A convalescing patient who does not finish the full course of treatment takes a grave risk. So too the most serious risk to recovery over the next several years is no longer the possibility of either financial strains or external shocks but that policy will shift too quickly away from maintaining adequate demand toward a concern with traditional fiscal and monetary prudence.
On even a pessimistic reading of the economy's potential, unemployment remains 2 percentage points above normal levels; employment, 5 million jobs below potential; and GDP, close to $1 trillion short of potential. Even with the economy creating 300,000 jobs a month and growing at 4 percent, it would take several years to reattain normal conditions. So a lurch back this year toward the kind of policies that are appropriate in normal times would be quite premature.
Indeed, recent research on what economists label hysteresis effects suggests that slowing could have highly adverse consequences. Brad Delong and I argue in a recent paper that it is even possible that premature and excessive movements toward fiscal contraction by shrinking the economy risk exacerbating long-run budget problems.
How then to respond to valid concerns about fiscal sustainability, excessive credit creation and the eventual return to normality in a world where policy credibility is essential? The right approach is to pursue policies that commit to normalize conditions but only when certain thresholds are crossed. The Federal Reserve might commit to maintain the current Fed Funds rate until some threshold with respect to unemployment or expected inflation is crossed. Commitments to fund infrastructure over many years might include a financing mechanism such as a gasoline tax that would be triggered when some level of employment or output growth has been achieved. Tax reform could phase in new rates in pace with the rising economic performance.
You state “Economic forecasters divide into two groups: those who cannot know the future but think they can, and those who recognize their inability to know the future.”
From the tone of this article you apparently belong to the first group.
Europe’s triple threat: bad banks, big debts, slow growth
The financial turmoil still dogging Europe is most often described as a debt crisis. But sovereign debt is only part of the problem, according to new research from Jay Shambaugh, economist at Georgetown’s McDonough School of Business. The other two prongs of what he describes as three coexisting crises are the region’s troubled banks and the prospect of an imminent recession.
These problems are mutually reinforcing, and require a more forceful policy response than the authorities have delivered to date. In particular, Shambaugh advocates using tax policy to lower labor costs, fiscal stimulus from those economies strong enough to afford it, and more aggressive action from the European Central Bank:
It is possible that coordinated shifts in payroll and consumption taxes could aid the painful process of internal devaluation. The EFSF could be used to capitalize banks and to help break the sovereign / bank link. Fiscal support in core countries could help spur growth. Finally, the ECB could provide liquidity to sovereigns and increase nominal GDP growth as well as allow slightly faster inflation to facilitate deleveraging and relative price adjustments across regions.
All these steps, especially if taken together in an attempt to treat the three crises holistically could substantially improve outcomes. At the same time, institutional reforms to create a true financial union and a common risk free asset could help both solve the current problems and reduce the connections of these crises in the future. Of course, politics, ideology, or additional economic shocks could all hinder improvement. The euro area is highly vulnerable and without deft policy may continue in crisis for a considerable amount of time.
