Europe and Eurasia

Europe

  • Europe
    European Banks: Balance Sheet Clarity But A Cloudy Future
    The European banking assessment results, released yesterday, were generally well received by markets. The test looked like earlier U.S. and Spanish stress tests in terms of structure, the results were in line with market expectations, and the report provided enough detail to keep analysts busy for weeks. This morning, the euro is firmer and European stocks were up a bit before weak data clawed them back.  Will this test succeed where previous efforts have failed and ultimately restore confidence in European banks? I suspect that your answer to this question depends on your outlook for the European economy. Without growth, Europe remains over-indebted, its banks undercapitalized, and a crisis return looks likely. European Central Bank (ECB) led the review and identified a capital shortfall of €25 billion at 25 banks, which was reduced to €9 billion (13 banks, none designated as systemically important) after taking account of capital raised so far this year.  Italian and Greek banks had the most problems, unsurprisingly. Assuming promised remedial actions fill about half of the remaining gap, the remaining capital shortfall is a modest €4.2 billion at only 8 banks, according to Morgan Stanley. However, using new, tougher capital rules (e.g., on goodwill and deferred tax assets) that will go into effect in the next few years raises the “fully-loaded” capital hole significantly and as many as 35 banks would have failed, according to several market analysts. The capital hole reflects a cleaning up of the balance sheets and a stress test, in roughly equal measure. The asset quality review (AQR) at the core of the exercise identified valuation problems at 130 banks, resulting in a markdown of the balance sheet by €48 billion. The ECB blamed poor valuation of commercial loans for much of the problem. It further criticized national regulators for underreporting non-performing loans (NPL) by €136 billion. That is a huge number, though on the positive side the move to a common, accepted standard for NPLs across the euro zone is a encouraging step. The stress test that was then applied to these cleansed balance sheets was a shock that depleted banks’ capital by €263 billion, reducing core capital by 4 percentage points from 12.4% to 8.3%. By comparison, the hit to capital in the well-received earlier Spanish stress test was 3.9 percent. Many analysts, including Nicolas Veron, argue that the exercise overall passes the smell test (though noting that we need to wait for the bank’s own reports next year to know for sure), while Philippe Legrain argues that it’s a whitewash.  I have some sympathy for Legrain’s argument—the review covers less than half of risk weighted assets, in part because it did not address problems at smaller banks (around 20 percent of euro area assets), notably German savings banks, and the macro stress test looks less stressful now (in light of weak recent data) than it did when they decided on it.  The stress test does include serious market and growth shocks (though not litigation costs that are likely to be a material headwind for the major banks). However, the inflation numbers in the stress test are above current levels, which seems surprising given broad concerns about low inflation (if not deflation) in the euro zone. This suggests that the macro scenario is faulty if very low inflation creates a risk to bank balance sheets beyond the conventional stresses that were addressed. The bottom line is that those of us that have been critical of Europe’s macro policies, and concerned that the baseline growth scenarios are too sanguine, are unlikely to draw much comfort from this stress test. Even a successful stress test is unlikely to restart the flow of credit quickly. Europe remains too bank-centric, too little is being done to restart credit to small and medium enterprises, and broader demand support is needed. Absent these moves, inadequate monetary and fiscal policies may quickly render this stress test, like the earlier ones, unconvincing.  
    Blog Post by Robert Kahn October 27, 2014 Macro and Markets
  • Europe
    A Paris Club for Europe
    Europe's strategy for solving its debt woes has the problem exactly backwards. A gaping hole in Europe's policy response to date is its unwillingness to reduce excessive levels of corporate, bank, and sovereign debt accrued during the global financial crisis and its aftermath. This debt has had a corrosive effect on investment and confidence, contributes to deflationary pressures, and undermines the public's trust in its economic future. Yet European leaders have not definitively addressed this challenge, hopeful that payment deferrals and an eventual return to growth will allow countries to outgrow their debt. This policy has produced a temporary improvement in market access at the cost of longer-term sustainability, contributing to an anemic recovery that is insufficient to address extremely high unemployment rates. A lost decade looms. A comprehensive, predictable, and rules-based program of debt reduction for over-indebted countries in the periphery of Europe can break the cycle of low growth and rising debt. Though there are many ways forward, one promising approach comes from the Paris Club, the informal group of official creditors that provides debt relief to low-income countries conditional on strong economic performance. The Problem: Growth, Debt, and the Doom Loop In the four years since Greece first approached the International Monetary Fund (IMF) for a bailout, the periphery countries have been at the epicenter of the crisis. In response, Europe created rescue funds, eased monetary policy, and made substantial structural reforms to labor and product markets. As a consequence, Europe has moved beyond the series of crises and emergency weekend meetings that dominated the last several years. Backed by strong policy support from the European Central Bank (ECB), capital has flowed back into the debt of periphery countries. However, it would be a mistake to assume that the crisis is resolved. The outlook for growth—at around 1 percent through 2015—remains below trend and far too low to meaningfully reduce crushingly high levels of unemployment, especially youth unemployment, which exceeds 35 percent in Spain, Greece, Portugal, and Italy. As the sense of crisis has receded, the pressure for ambitious solutions has dissipated. Yet opinion polls show a growing dissatisfaction with Europe's course, and May's European parliamentary elections delivered a strong message of voter impatience with current leaders and their policies. The pressing challenge for Europe is to restore growth before markets and voters again lose confidence in the reform process. One of the central lessons from past crises is that high levels of debt can be a substantial and sustained drag on growth. In recent years, European governments have seen explosive increases in their debt ratios. In some cases, this reflects large fiscal deficits (e.g., Greece and Portugal); in other cases, the costs of supporting national banks played a significant role (e.g., Ireland and Spain). Low growth contributes to balance-sheet stress for banks and corporations, which in turn exacerbates financial distress—a "doom loop" between sovereigns and their banks that will damage growth. In the near term, ECB support ensures that these countries retain market access, but at the cost of higher future debt. Over time, rising debt service costs will exact a price in terms of confidence, reduced cross-border investment, and fragmented credit markets that will be particularly damaging for smaller, non-systemic borrowers across the periphery of Europe.. The sharing of costs across the union would break the doom loop. Yet a defining feature of the European policy response to the crisis has been concern over moral hazard and resistance to the notion that Europe would become a "transfer union." Creditor countries—led by Germany—consequently have insisted that the mechanisms through which fiscal union would be achieved—e.g., eurobonds and fiscal transfer, or a full banking union that shares costs of bank restructuring—can only come at the end of the reform process, if at all. Rather than acknowledge that the legacy debt has to be reduced to make current policies sustainable and create incentives for new investment, countries are forced to shoulder the burden of that debt with the uncertain hope of future debt relief. This presents two problems. First, it is highly uncertain that debt relief offered through undefined future interest-rate reductions will be adequate to restore debt sustainability. Second, the overhang of debt in effect subordinates other investors—including private investors—to official creditors. There is no single percentage of debt relative to gross domestic product (GDP) above which a country is definitively insolvent. That threshold will vary across countries based on a range of economic, political, and social factors. But resolving the debt overhang in the periphery will require acknowledging that it will be nearly impossible for these countries to grow their way out of existing debt levels. There would appear to be increasing acceptance of the need for debt relief, but an inability, at least for now, to discuss it. Greece in the Vanguard (Again) Nowhere is the corrosive linkage between debt and growth more on display than in Greece. Two years after its debt restructuring, the government had a successful return to markets, issuing a five-year bond at 4.95 percent. Investors' interest was supported by a reach for yield and a view that a short-term bond issue will be paid before the current moratorium on interest payments expires in eight years, rather than an improved sense of Greece's long-term creditworthiness. Such optimism may be short-lived, and policymakers may soon need to acknowledge that substantial further debt relief is needed. Greek public debt even after restructuring is around 175 percent of GDP, and in the IMF's low-growth scenario sees little or no improvement over the next decade. Greece is not alone. Throughout Europe, corporate debt is high and rising, while the European Central Bank­–led banking assessment at the end of October will lead to additional costs of cleaning up the banking system. Ultimately, the responsibility for fixing corporate and bank balance sheets will fall on national governments. A contentious public debate may refocus investor attention on the unsustainability of current debt levels. Paris Club Lessons It is an unfortunate reality that over the last thirty years the world has had a great deal of practice resolving international debt crises. Though the circumstances differ, one common theme runs through the official responses to the developing-country debt crisis of the 1980s, the East Asian financial crisis of the 1990s, and the Great Recession. In addition to the implementation of new policies to reduce the risk of future crises, each case required a solution to the debt overhang in order to achieve a durable return to growth. Fortunately, there is an effective model for dealing with a debt overhang: the Paris Club, an informal group of official creditors that has met since 1956 to deal with payment problems of emerging market debtor countries. For countries in crisis, the Paris Club provides rescheduling of sovereign debt owed to official creditors. Though the Paris Club's operations, geared as they are to low- and middle-income countries under IMF programs, may seem ill-designed for the large, complex industrial economies of Europe, three of its principles should be central to the European approach. First, the Paris Club has a set of rules for the terms of restructuring based on the countries' income and debt level and are known in advance. In practice, the scale of debt relief will depend on a case-by-case assessment of the financing need of each program. Second, Paris Club restructurings are conditional on a proven record of performance under an IMF program. In the European context, there is an unfortunate stigma associated with IMF programs and conditionality, but nonetheless making relief conditional on performance is essential to address legitimate moral hazard concerns. The third principle is seniority for new lending and for trade finance. The Paris Club sets a cutoff date and the restructuring, as well as any future restructuring, will apply only to debt originally contracted before that date. New lending is therefore senior to old debt, in practice, which creates an environment that encourages capital to return. If this framework extended to Europe's periphery, confidence and incentives for new lending would be strengthened. What Europe Should Do Next With the release of the banking assessment and stress test toward the end of October, uncertainty about the effects of debt relief on banks is no longer an excuse for inaction. Europe needs to begin negotiations this year on a rules-based approach to official-sector debt relief, in which countries meeting firm conditionality would be assured of adequate (and predictable) relief. This approach would have the following elements: countries would receive a cutoff date and debt acquired before that date would be eligible for restructuring; restructurings would be tranched; and assistance would be conditional on policy performance, including structural reforms, continued progress toward macroeconomic balance, and programs for restructuring over-indebted corporate sectors. Though it is difficult to quantify the effect of reducing debt on the European economy, some estimates suggest that the resultant rebound in investment could raise European trend growth by up to one percentage point. Critics will argue that debt relief is unnecessary when maturities have been extended and where additional concessions could be offered in the future if needed. That argument fails to be convincing, as the current approach creates uncertainty about whether adequate relief will be given, which policies the country should implement, and if austerity will someday end. Further, as seen in the case of Greece, long-term official debt does not impose market discipline on private lenders (though it does mean that new private debt will be short term, exacerbating the risk of future runs). European leaders are understandably concerned about the costs of setting precedents when dealing with the crisis of the moment, as well as implementing a crisis-management approach associated with low-income emerging markets. But the costs of inaction are growing too large. Europe needs a Paris Club for European debt. Call it a consultative group if need be; hold it in Berlin, Amsterdam, or Brussels. The sooner these rules are established, the sooner Europe will see a return to growth.
    Policy Innovation Memorandum by Robert Kahn October 27, 2014 Greenberg Center for Geoeconomic Studies
  • Europe
    When meetings matter—The World Bank and IMF Convene
    There are many reasons cited for this week’s market turndown and risk pullback, including concerns about global growth, Ebola, turmoil in the Middle East, and excessive investor comfort from easy money. What has been less commented on is the role played by last weekend’s IMF and World Bank Annual Meetings. Sometimes these meetings pass uneventfully, but sometimes bringing so many people together—policymakers and market people—creates a conversation that moves the consensus and as a result moves markets. It seems this year’s was one of those occasions. As the meetings progressed, optimism about a G-20 growth agenda and infrastructure boom receded and concerns about growth outside of the United States began to dominate the discussion. The perception that policymakers—particularly European policymakers—were either unable or unwilling to act contributed to the gloom. Time will tell whether macro risk factors that markets have shrugged off over the past few years will now be a source of volatility going forward. But if that is the case, perhaps these meetings had something to do with it. A few other thoughts on the meetings. Markets are ahead of policymakers on European QE. Europe is divided on whether quantitative easing is needed, and if tried, whether it will be effective. While most market participants seem to expect the ECB to soon extend its program of quantitative easing to buying government bonds, current and ex-central bankers at presentations I attended signaled a greater degree of uncertainty. Part of the concern is whether the usual channels through which QE works—including a wealth effect on portfolios—will work as well in Europe’s bank dominated system as it did in the United States, but the greater concern is gridlocked politics. This was highlighted by the public disagreement between ECB head Draghi and Bundesbank President Weidmann, as noted by several commentators. The risk is that the easing of policy comes late, and doesn’t pack the punch that is needed to restore growth. We know from the U.S. experience that a potentially important channel for unconventional monetary policy comes from the forward guidance it provides that easy policy will be sustained. True, the ECB has some tools the Fed does not have (e.g., long-term fixed rate lending facilities) to signal that rates will stay low for a long time. Yet, at a time when policymakers elsewhere are increasingly focused on the challenge of exiting that guidance, the hesitancy of the ECB to clearly articulate its goals for and commitment to an expansion of its balance sheet and increased liquidity can only undermine the impact of current monetary policy. The policy response to divergent monetary policies is starting to take shape. Much of the policy discussion tried to anticipate a world in which the Federal Reserve began to normalize policy while the Bank of Japan and ECB expanded their use of unconventional monetary policies. Exchange rates, particularly emerging market exchange rates, were seen as a source of future volatility. In this regard, I was surprised I did not hear more about the risk of protectionism (in the United States for example if the dollar rises sharply) or capital controls (in emerging markets) if we have a normalization nightmare, following on the taper tantrum of last year. The continued criticism of the Fed by Indian central bank governor Rajan seems to have less to do with policy (the Fed’s actions having supported global growth and its possible exit well communicated) as much as it may suggest preparation to resist the market pressures that will result. The outlook is deteriorating for Russia and Ukraine. There is increasing anecdotal evidence that pressures on the Russian financial system are mounting and extending to non-sanctioned banks. The recent depreciation of the rouble and capital outflows have intensified concerns, and notwithstanding substantial central bank and government support it seems clear that Russia has dropped into recession. Most of the market forecasts still see positive growth this year, but I expect that to change after these meetings. Meanwhile, I didn’t need the meetings to tell me that the IMF’s program for Ukraine is collapsing, a victim of continued Russian destabilization, a deep recession, and ridiculously optimistic initial IMF assumptions. What surprised me was the weak defense put up by the official community at these meetings. The IMF team that will go to Kiev in early November, after Parliamentary elections, has little choice but to positively conclude its review and disburse the roughly $2.7 billion due Ukraine in December, given rising cash needs of the government heading into winter. But I suspect (and hope) that the review will acknowledge the large and growing financing needs of the country and the limits of the Fund’s ability to meet these needs and introduce sustainable economic reform in the midst of a conflict. The Fund should signal that it may have to step back as soon as the next review (in March), and that bilateral support from the United States and European governments needs to fill the gap. That new package (with a private debt restructuring to extend maturities) needs to be in place by March, if not sooner.
    Blog Post by Robert Kahn October 16, 2014 Macro and Markets
  • Global
    The World Next Week: October 16, 2014
    Podcast
    The European Council holds a summit in Brussels; three years passes since the death of Libya's al-Qaddafi; and World Polio Day takes on a new importance.
    Podcast with James M. Lindsay and Robert McMahon October 16, 2014 The World Next Week
  • Europe
    The Geopolitical Paradox: Dangerous World, Resilient Markets
    Should we be worried by how well global markets are performing despite rising geopolitical volatility? I think so. In my September monthly, I look at the main arguments explaining the disconnect, and argue Europe is the region we should be most worried about a disruptive correction. Here are a few excerpts. • Far Away and Uncorrelated. Much of the market commentary has stressed that the risks that most worry political analysts—for example Russia, ISIL and Syria, Syria, an Ebola pandemic—are not necessarily central to global growth and market prospects. But small (in GDP terms)and far away does not mean inconsequential. As the debate over financial sanctions has shown, its Russia’s leverage and interconnectedness, rather than its global trade share, that makes comprehensive sanctions so powerful and potentially disruptive. • A Sea of Global Liquidity. There is little doubt that the highly accommodative monetary policies of the United States, eurozone, United Kingdom, and Japan have provided an important firewall against geopolitical risk. Looking ahead, global liquidity will remain ample, but with the U.S. and U.K. beginning to normalize, and the BOJ and ECB going in the other direction, the divergence of monetary policies creates conditions for increased market volatility. Foreign exchange markets in particular appear vulnerable, as history suggests these markets are often bellwethers of divergent monetary policies. • Confident Oil Markets. A stable and moderate global expansion that has limited demand, as well as the revolution in fracking and other technologies, has allowed Saudi Arabia to maintain substantial spare capacity, thereby limiting the potential for a supply disruption to roil markets in the near term (though the longer-term buffering effects on market prices from these developments can be overestimated). But it is hard to imagine that broad based turmoil in the middle east, and the possible rewriting of borders, can be achieved without a material disruption to supplies at some point. • Europe as the Weak Link. I see Europe as the channel through which political risk could reverberate in the global economy. The standoff with Russia, or a hard landing in China could significantly affect exports, particularly in Germany. Significantly, though, Europe also faces these challenges at a time of economic stress and limited resilience. Growth in the region has disappointed and leading indicators have tilted downward. Further, concern about deflation is beginning to weigh on sentiment and investment. The persistence of low inflation is symptomatic of deeper structural problems facing the eurozone, including an incomplete monetary union, deep-seated competitiveness problems in the periphery, and devastatingly high unemployment. Homegrown political risks also threaten to add to the turmoil, as rising discontent within Europe over the costs of austerity is undermining governing parties and fueling populism. The result is a monetary union with little capacity or resilience to defend against shocks. The ECB has responded to these risks with interest-rate cuts and asset purchases, and is expected to move to quantitative easing later this year or early next, but the move comes late, and is unlikely to do more than address the headwinds associated with the ongoing banking reform and continued fiscal austerity. Overall, a return to crisis is an increasing concern and political risks could be the trigger that we should be worried about.
    Blog Post by Robert Kahn September 10, 2014 Macro and Markets
  • Europe
    EU Sanctions Rules Released
    The rules for implementing new EU sanctions against Russia have been released (see also here and here).  On quick glance, they are, as advertised, an important step that will have systemic effects in financial, energy and defense markets. In this respect, they are "sectoral" or "level three" sanctions in the language of policymakers.  While narrow in scope-- the financial ban (Article V) is on new transferable securities of majority state-owned Russian banks with maturities greater than 90 days--one is left with the impression that Europe, like the United States, stands ready to extend the sanctions if there is evasion or further Russian efforts to destabilize Ukraine.    
    Blog Post by Robert Kahn July 31, 2014 Macro and Markets
  • Europe
    Do the European Parliamentary Elections Matter?
    This week’s European parliament elections could mark a victory for eurosceptics and fringe political groups, an outcome that would likely sour transatlantic relations, says expert Judy Dempsey.
    Interview with Judy Dempsey and Jeanne Park May 22, 2014
  • Italy
    Political Dialogue and Institutional Reform Needed to Resolve the Crisis in Ukraine
    Play
    With Italy preparing to assume the presidency of the European Union in July, Italian Foreign Minister Federica Mogherini joins Lally Weymouth of the Washington Post to discuss current Italian diplomatic efforts.
    Event with Federica Mogherini and Lally Weymouth May 16, 2014
  • Italy
    Political Dialogue and Institutional Reform Needed to Resolve the Crisis in Ukraine
    Play
    With Italy preparing to assume the presidency of the European Union in July, Italian foreign minister Federica Mogherini joins Lally Weymouth of the Washington Post to discuss current Italian diplomatic efforts.
    Event May 16, 2014
  • Germany
    Globalizing World Requires Transatlantic Partnership and Leadership
    Play
    With the economic structural reforms enacted in many southern European countries now beginning to show results, German Finance Minister Wolfgang Schäuble joins Robert M. Kimmitt of the American Council of Germany to discuss the current state of the European economic recovery.
    Event with Wolfgang Schäuble and Robert M. Kimmitt April 11, 2014
  • Germany
    Globalizing World Requires Transatlantic Partnership and Leadership
    Play
    With the economic structural reforms enacted in many southern European countries now beginning to show results, German finance minister Wolfgang Schäuble joins Robert Kimmitt of the American Council of Germany to discuss the current state of the European economic recovery.
    Event April 11, 2014
  • Europe
    IMF/World Bank Spring Meetings: Three Questions
    The IMF/World Bank spring meetings start today, with a broad agenda and amidst significant global uncertainty.  A good discussion of the agenda is here  and of the Fund’s view is here.  Here are three questions on which I am looking for news, and perhaps even answers. Have we lost confidence in our global growth story? IMF’s global outlook is reasonably sanguine:  the IMF forecasts global growth to average 3.6 percent in 2014--up from 3 percent in 2013--and to rise to 3.9 percent in 2015, led by a solid U.S. recovery. They argue that global headwinds from the great recession are receding, allowing monetary policy—both conventional and unconventional—to normalize. Yet the hallway discussion will be on the new threats to global economy, most notably geopolitical tensions with Russia and in Asia, and what policymakers need to do to prepare.  Most significantly, an intensification of sanctions against Russia could have significant effects on trade and investment, and cause substantial deleveraging in global financial markets. With fiscal authorities for the most part having limited room to offset this shock, contingency planning likely will focus on central bank monetary policy and liquidity facilities (e.g., swap lines). Is this enough? Beyond the evident cyclical risks, a broader question is whether we are too optimistic about trend growth.  In the emerging markets in particular, optimism about growth and convergence has been tempered by weakening performance and more adverse external conditions (e.g., capital outflows, falling export demand due to lower China growth).  From this perspective, the taper tantrum of last year is a false issue (though some emerging market policymakers will still raise it for domestic political purposes); communication is good and the Fed is well aware of the implications of its policies on the world (though they are always cautious in talking about their systemic responsibilities given their legal dual mandate on price stability and employment).  The real issue is whether domestic policies are supportive of growth aspirations. And if not, is there scope, economic and political (with elections coming up in a number of countries), to change policies to restore the momentum of growth? Or is the emerging market growth model broken? How do we reform the IMF?  It appears that the main headline from these meetings will be a new effort to restart IMF reform. The disappointing refusal of the U.S. Congress to pass the IMF reform package will do long-run damage to America’s soft power and the ability to build consensus in difficult crisis resolution issues. But what is the solution? Ted Truman has an interesting idea for the Fund to end-run the U.S. Congress  but I think going around legislatures is too politically dangerous in the United States and elsewhere.  Perhaps more reasonable would be to “combine" the 14th and 15th quota review.  Translated, this means that the agreement would be set aside and a new negotiation begun.  The U.S. administration could commit to the negotiation with Congressional approval, deferring Congressional approval for a better day. Will the rising powers be satisfied with an approach that delays them having an appropriate representative voice in the organization? Is low inflation a major global risk?  A few weeks ago, the IMF had a great blog on the risks for Europe from persistently low inflation (“lowflation”).  Their argument was, at its core, that even absent deflation, low inflation  raises real interest rates and the burden of debt, inhibits adjustment, and  weakens demand. While the issue is most salient for Europe, we could ask the question more broadly. Lower China growth and the turn in the commodity cycle is a drag on export prospects of many countries, particularly commodity-exporting emerging markets. Corporate leverage in Europe and emerging markets is dangerously high. High levels of unemployment remain a critical social and economic problem.  Are disinflationary pressures dampening global growth prospects?  
    Blog Post by Robert Kahn April 10, 2014 Macro and Markets
  • Europe and Eurasia
    The European Union’s Eastern Partnership
    The most recent crisis in Ukraine has invited closer scrutiny of the European Union’s approach to its Eastern neighbors.
    Backgrounder by Jeanne Park March 13, 2014
  • Europe
    Europe’s December Surprise?
    Over the past year, Europe has enjoyed calm financial markets.  At the core of the market’s comfort were two assumptions about policy. First, that the European governments would do just enough to keep the process of European integration moving forward. Second, that the ECB would, in the words of Mario Draghi, do “whatever it takes”  to save the euro. The centerpiece of the ECB’s subsequent efforts was expanded liquidity (through long-term repurchase operations and easier collateral requirements for banks to access ECB liquidity) and a commitment to purchase government bonds to support countries return to market (the OMT program).  Even many pessimists who fear that Europe is trapped on a unsustainable, low-growth trajectory remain optimistic that Europe will do what it takes to navigate the near term risks.  It may be time to question that optimism. As many have noted, there is an increasing sense of adjustment fatigue in Europe, reflected in pressure on governments and the rise of anti-austerity, anti-establishment parties across the Eurozone.  In rhetorical terms, Europe has responded, and fiscal policy looks likely to be broadly neutral in the year ahead.  However, an overall fiscal relaxation that is needed in the euro area as a whole looks unlikely, as peripheral countries can’t afford much additional spending, while the core countries that can spend more seem disinclined to. Monetary policy also falls short of what is needed to establish the conditions for growth.  Unlike the United States, where a decision to recapitalize banks was coupled with strong Federal Reserve easing policies that established the basis of recovery, the ECB has to date resisted quantitative easing or a significant easing of collateral requirements to spur lending to small and medium enterprises (SMEs) in the periphery.  While it’s fair to point out that the ECB faces a more constraining legal and governance framework than the Fed, it’s also hard as a result to be confident in the IMF’s (and others) view that recovery is coming to Europe in 2014.  Even the IMF acknowledges that currently, "centrifugal forces across the euro area remain serious and are pulling down growth everywhere." Finally, there seems to be little political consensus on creating a true banking union (with deposit insurance and a strong pan-European resolution authority), dealing with the legacy sovereign debt, or honestly addressing the scale of the non-performing loan problem.  All these are critical to a long-term solution to the crisis.  All of these are long-term pressures on Spain, France and Italy, on which the future of the Eurozone no doubt rests. However, in the coming months Europe will face tests from a number of smaller countries.  Notably, economic programs in Greece, Cyprus and Portugal are all heading off track.  In the case of Greece, money promised for later years has been moved forward, resulting in a financing gap that will be impossible to ignore at the next review of the program in September.  Cyprus will need expanded ECB access if it is to ease capital controls.  Each of these countries will require new programs with more money, and eventually a debt restructuring.  Reviews of these programs in the fall likely will be too early for Europe to agree to debt official debt reduction, but fresh new money with an unsustainable debt profile may be similarly hard to justify.  Meanwhile, Ireland looks ready to press for better treatment on its debt as well. In each of these cases, the argument has been made that concessions cannot be made to these countries ahead of German elections in September (and  a German constitutional court ruling  on the ECB’s bond-purchase program).  This of course creates expectations that things will be much better for these countries after elections.  There is talk of a December European leader’s meeting being the forum for a “move towards more Europe.” The problem is not the scale of the support needed in each cases.  These are small programs that can readily afford to be expanded within the existing framework.  The problem is that they could become the place where broader battles over the future of Europe–on official sector debt reduction, on banking union, and on fiscal federalism—are fought out.  In that case, will existing ECB liquidity facilities and the threat of OMT be enough to keep markets calm?  If pressures on banks or governments intensify, questions will no doubt be raised on whether the ECB’s threat to buy bonds is a bluff.  It’s hard to imagine countries accepting material new conditionality to access the bond-buying facility, or that the ECB could materially ease its conditions for use.  The period of financial market calm may be coming to an end.
    Blog Post by Robert Kahn July 11, 2013 Macro and Markets
  • Europe
    The IMF’s Outlook: Less Growth, Inadequate Policies
    The IMF is out with a global update and a statement on Europe.  Unsurprisingly, it has revised its outlook down (again).  It still, optimistically, expects a return to growth in Europe next year, but it recognizes the risks are on the downside.  A few points to highlight. 1.       We are all in this together. The largest downward revision is to emerging markets (-0.3% revision this year and next).  While there are idiosyncratic factors (e.g., credit squeeze in China, infrastructure in India, lessened policy support in Brazil), the common issue affecting the emerging world is a weaker external environment due to slow industrial country growth.  I’d emphasize here, of course, that these countries can depreciate their exchange rates, ensuring a faster recovery than we will see in the periphery of Europe. 2.      Downside risks dominate.  The reports candidly acknowledge the downside risks, including the upcoming debt-ceiling fight in the United States and deteriorating financial conditions in Europe.  The overall sense is of a Fund frustrated with policies across the major industrial countries (except Japan, where it has revised growth up on Abenomics) 3.      A boost to macroprudential  regulation.  The Fund continues to support  accommodative monetary policies in the G3; thus its not surprising that they emphasize regulatory and macroprudential policies to deal with potential bubbles.  This ties in with earlier Fund work suggesting a more positive view of macroprudential measures and capital controls to address financial imbalances. 4.      For Europe, easier fiscal and monetary policies.   They support further rate cuts from the ECB (including negative ECB deposit rates) and endorse the ECB’s recent forward guidance.  Further fiscal “flexibility” is likely to be needed in Europe, as current targets are unlikely to be met. I don’t think there is much new here, but it’s still the right call. 5.      The path to European union must be accelerated. More aggressive measures to repair bank balance sheets, a faster move to banking union, and stronger ECB efforts to reduce fragmentation are needed.  On the latter, they support new long-term lending (LTRO) coupled with an easing of collateral requirements to provide a greater incentive to lend to the periphery.  This approach mirrors the “funding for lending” scheme in the United Kingdom.  They also would support ECB purchase of private assets, a more full-throated quantitative easing (QE). The Fund clearly is increasingly unhappy with the policy framework in Europe.  The question is what, if anything, they will do about it.  The test will likely come this fall on Greece, Portugal, and Cyprus--all programs that seemed destined to fail without stronger European support.
    Blog Post by Robert Kahn July 9, 2013 Macro and Markets