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Les habits neufs des dirigeants européens

Donald Tsang, le chief executive de Hong Kong, l’a avoué tout crument : cela fait trente ans que j’exerce des responsabilités publiques, a-t-il dit, et je n’ai jamais eu aussi peur. Peur de l’onde de choc d’une crise lointaine née dans un petit pays de la périphérie européenne, dont les effets percolent dans tout le système économique mondial. Et surtout, peur des préventions des Européens, qui ne veulent pas trop s’écarter des chemins balisés. En 1997-98, leur a-t-il dit, au plus fort de la crise asiatique, je n’ai pas reculé devant les mesures radicales : comme ministre des finances, j’ai même acheté des actions pour stabiliser le marché. Alors ne craignez pas d’être radicaux, ne craignez pas de trop en faire, et faites vite.

A Davos en janvier comme à Cannes en novembre ou à Washington en septembre, un seul sujet a encore une fois focalisé l’attention : la crise européenne. Chacun a exprimé son inquiétude, chacun y est allé de son conseil aux responsables de la zone euro, en général pour leur dire qu’ils manquaient toujours d’ambition et d’audace. Comme d’habitude, ceux-ci se sont (à l’exception de Mario Draghi, le président de la BCE) exprimés sans beaucoup de force et d’éloquence. Et pourtant, la zone a aujourd’hui une stratégie de réponse à la crise, elle a commencé de la mettre en œuvre, et elle peut afficher quelques résultats. Cela ne veut pas dire que cette stratégie soit sans problèmes, au contraire plusieurs points méritent amplement débat. Mais avant de la discuter il faut la comprendre.

Cette stratégie repose sur trois volets : traiter la crise grecque, maintenir les banques à flot, et forcer les Etats à l’austérité.

Sur la Grèce les Européens ont passé deux ans à hésiter : fallait-il aider ou pas ? Fallait-il qu’Athènes rembourse ses dettes ou faire payer ses créanciers ? Ils ont pour l’essentiel tranché. Dans les négociations avec les banques ils poussent à une forte réduction de la dette grecque, de l’ordre des deux-tiers en valeur actualisée. Les questions en suspens restent de savoir si Athènes va passer une loi pour étendre l’accord de réduction de dette aux créanciers qui ne sont pas partie prenante à la négociation (les hedge funds notamment) et si la Banque Centrale Européenne, qui est devenue créancière en achetant des titres grecs sur le marché, va devoir participer à l’effort (elle bénéficiera certainement d’un traitement particulier). Mais on est loin de l’obstination à prétendre que la Grèce était solvable qui prévalait jusqu’à juillet dernier, loin même de la mini-réduction de dette sur laquelle on s’était mis d’accord à l’été. Pour autant, la crise grecque n’est évidemment pas terminée. Elle peut à tout moment rebondir, et jeter le trouble sur les marchés. Personne ne peut garantir que l’allégement de la dette suffira à fournir les bases d’un redressement de l’économie, et l’Europe, qui pourrait faire plus pour la croissance avec les instruments dont elle dispose, hésite à s’engager dans une intervention plus ambitieuse. L’Allemagne, qui s’énerve de plus en plus devant les atermoiements du gouvernement d’Athènes, va jusqu’à demander que le contrôle du budget soit confié à un proconsul. Tout le monde se demande aussi si le Portugal va suivre les traces de la Grèce. Mais au moins, une étape va être franchie.

Sur le deuxième volet, celui des banques, la BCE a pris le taureau par les cornes en engageant fin décembre une opération massive de prêt à trois ans au système bancaire. On sait aujourd’hui, sur la base des statistiques qui viennent d’être publiées, que la zone euro était en cours d’asphyxie sous l’effet d’une brutale contraction du crédit, et que l’attrition des prêts interbancaires menaçait de mettre à bas les établissements de crédit les plus fragiles. La fourniture de liquidités a soudainement remis de l’oxygène dans le système bancaire, et a permis aux banques de recommencer à acheter des titres d’Etat, avec pour effet une baisse des taux d’intérêt payés par l’Espagne ou l’Italie. Dans le même temps l’action de la BCE a tranché un débat qui avait occupé tout l’automne : Francfort a fait clairement comprendre que sa mission était de s’occuper des banques, et qu’il appartenait aux Etats de se sauver eux-mêmes. Cette action d’urgence ne résout pas les problèmes de fond, elle pourrait même accentuer la dangereuse interdépendance entre banques et Etats si les banques espagnoles utilisent la liquidité qui leur est fournie pour acheter des obligations d’Etat espagnoles et les banques italiennes des obligations italiennes. Mais éloigne un peu les menaces immédiates.

Le troisième volet est apparemment budgétaire, mais en réalité aussi économique. Avec le nouveau traité à vingt-cinq sur la discipline budgétaire les Européens ont,  à l’insistance de l’Allemagne, choisi de lire la crise à travers le prisme grec, et de donner priorité à la répression des manquements à la discipline budgétaire. Cette lecture est contestable, parce que l’Espagne ou l’Irlande n’ont jamais été pris en défaut d’observance du Pacte de stabilité, parce qu’elle oublie quel a été le rôle du crédit privé dans l’accumulation des déséquilibres des années 2000. Mais il serait erroné de soupçonner ses promoteurs d’aveuglement ou de naïveté. Ceux pour qui la rédemption passe par l’austérité sont convaincus que seule une cure forcée d’assainissement budgétaire convaincra les gouvernements de réformer leurs économies. Comme Mario Draghi, le président de la BCE, l’a dit à Davos, nous avons traversé diverses conjonctures au cours des dernières années, des périodes de taux d’intérêt haut et bas, mais certains pays (il pensait visiblement à l’Italie) n’ont jamais réussi à croître. Cette crise doit être l’occasion de lever les obstacles à l’investissement et au développement. C’est largement pour la même raison que l’Allemagne refuse d’augmenter la hauteur du « pare-feu » au-delà des 500 milliards d’euros sur lesquels l’accord s’est fait en décembre : à trop mettre les gouvernements à l’abri des marchés, pense-t-elle, on risque de décourager les intentions de réforme.

L’austérité est donc plus qu’une potion amère destinée à remettre d’aplomb les finances publiques, elle est pensée comme l’aiguillon de la transformation économique. Le pari est osé : la multiplication des plans de rigueur peut entraîner les Etats dans un cercle vicieux, l’astreinte budgétaire peut, comme on l’a vu en Grèce, décourager les efforts de réforme économique plutôt que les stimuler. Après tout, les gouvernants disposent d’un certain capital politique, qu’ils doivent allouer entre le rétablissement des comptes et la mise en œuvre de réformes. L’un peut facilement contrarier l’autre. Mais encore une fois, on ne peut pas reprocher à l’Europe de ne pas faire de choix.  

Même si les Européens donnent toujours l’image de l’indécision et de la division, les choses ont donc en fait changé : une stratégie se met en place, dont les prochains mois et les prochaines années nous diront les effets. Cette stratégie ne repose pas sur un renforcement de l’intégration entre pays participant à l’euro, comme l’ont proposé différents observateurs – y compris, à Davos, David Cameron, le premier ministre britannique, dans un surprenant discours mêlant critique acerbe de l’Union européenne et appel au renforcement de la zone euro ; ou du moins elle ne l’implique pas encore. Elle ne passe pas par un renforcement de la capacité d’intervention sur les marchés que les Etats-Unis jugent indispensable, et dont un certain nombre de pays partenaires font la condition d’un soutien à la zone euro via le FMI. Et malgré les encouragements des chefs d’Etat à des initiatives de croissance, elle assume le risque qu’une récession finisse par décourager les énergies des gouvernants plutôt que de les stimuler. Elle est donc contestable et risquée, et c’est pour cela sans doute qu’elle fait peur à Donald Tsang. Mais, au moins, elle existe.

Colonne publiée dans le Huffington Post le 31 janvier 2012 

La politique n’est pas condamnée à rester en berne

Dans tous les pays européens en difficulté, les partis traditionnels ont été incapables de structurer un débat sur les réponses à la crise. En Grèce, la politique est mise entre parenthèses le temps de négociations financières vitales pour l’avenir du pays. En Italie, Mario Monti  et son gouvernement de technocrates se sont substitués à une gauche inaudible pour offrir une alternative à Silvio Berlusconi. En Espagne, la droite de Mariano Rajoy a brillamment gagné en prenant bien soin de ne rien dire sur rien. Au Portugal, celle de Passos Coelho l’a emporté en promettant d’appliquer avec plus de conviction les mêmes mesures que le socialiste Socrates. Partout la politique est en berne, comme si les temps étaient trop durs pour elle.

Le phénomène n’est pas universel. Aux Etats-Unis et au Royaume-Uni, le clivage traditionnel est plus pertinent que jamais, notamment autour du rôle de l’Etat. Mais en zone euro, et notamment en France, l’interrogation demeure : droite et gauche sont-elles encore capables d'offrir un choix ? Un ouvrage récent du Cercle des Economistes (Droite contre Gauche ? sous la direction de J.-H. Lorenzi et O. Pastré, Fayard) aide à tracer les contours de ce que devrait être un débat présidentiel éclairant.

Commençons par les sujets qui ne relèvent pas de la décision nationale et sur lesquels, faute de pouvoir se différencier, les partis de gouvernement sont vouées à subir les attaques des forces antisystème : la monnaie, les normes de finances publiques, la politique commerciale, la concurrence, la réglementation financière, pour ne citer que les principaux. Cela fait beaucoup. Se sachant impuissants, les candidats sont tentés par des postures qui ne font qu’affaiblir leur crédibilité. La seule réponse est de faire émerger un débat politique structuré au niveau communautaire. Il serait temps que les candidats réalisent qu’ils doivent aussi porter investir ce terrain et que le maintien des partis européens à l’état d’ectoplasmes n’est pas dans leur propre intérêt. Cela s'applique particulièrement aux réponses à la crise de la zone euro, dont il importe de savoir si elles doivent privilégier la pénitence ou la croissance, la mutualisation des dettes ou la renationalisation des disciplines.       

Vient ensuite le domaine des choix contraints, à commencer par la politique budgétaire. Sous la pression des marchés et avec le durcissement des règles européennes, gauche et droite doivent viser une élimination du déficit sur la prochaine législature. Cela n’implique cependant pas la même politique : rythme et modalités du redressement, répartition des efforts entre prélèvements et baisses des dépenses, sélection des dépenses à sacrifier, répartition de l’ajustement niveaux d’administration, constituent autant de terrains potentiels de différentiation, sans compter la méthode retenue pour opérer. Aux politiques de s’en saisir et d’offrir un choix construit entre rigueur de droite et rigueur de gauche.

Il en va de même d’un autre clivage traditionnel, la répartition capital-travail. Les grands groupes internationalisés du CAC40 se portent bien, mais la rentabilité de l’investissement sur le territoire national est trop faible pour permettre un redressement des exportations et de l'emploi industriel. La prochaine équipe devra œuvrer à la profitabilité des entreprises. Reste le choix des moyens - politique fiscale ou salariale, intervention ciblée ou horizontale, encouragement à la montée en gamme ou soutien à l'emploi peu qualifié. Pour autant qu'on ne s'en tienne pas aux vieilles lunes, il y a là matière à de vrais débats.

Subsistent enfin des terrains de figures libres. Dans un contexte de creusement global des inégalités entre le 1% supérieur et les 99% restants, le plus marquant est sans conteste celui de la fiscalité des personnes. Cela fait bien longtemps que la France n’a pas connu un débat fiscal d’ampleur, et il serait bienvenu que la prochaine élection lui réserve une place centrale. Au-delà, bien d’autres questions comme le marché du travail, la jeunesse, l’éducation ou l’énergie se prêtent à franche différentiation.           

Pour peu que François Hollande et Nicolas Sarkozy le veuillent, ils peuvent donc offrir aux citoyens le choix entre deux lectures de la situation et deux ensembles de solutions. François Bayrou et Eva Joly peuvent également proposer les leurs. Le vrai risque pour la démocratie n'est pas que la situation fixe des contraintes. Il est que les candidats se gardent d'une expression claire de peur de réveiller des divisons au sein de leur propre camp. Si, par souci tactique, l'ambigüité devait prévaloir, alors oui, on pourrait dire que la politique a été mise en berne pendant l'élection. Les Français méritent mieux.

 

Chronique publiée dans Le Monde du 24 janvier 2012

 

Politics doesn’t have to remain in suspended animation

In all the troubled European countries, traditional political parties have been incapable of structuring a debate on how to respond to the crisis. In Greece, politics has been parked while vital financial negotiations take place with creditors and the Troika. In Italy, Mario Monti and his government of technocrats have replaced a voiceless Left as an alternative to Silvio Berlusconi. In Spain, the Right led by Mario Rajoy has scored a brilliant victory by carefully avoiding being specific about policy. In Portugal, Passos Coelho won by promising to implement the same measures as the Socialists of Socrates, only with more conviction. Everywhere party politics seems to be in suspended animation, as if the times were too tough for it.

This phenomenon is not universal. In the US and the UK, the traditional battle-lines are as relevant as ever, especially on the role of government. But in the Eurozone doubts are widespread: are both Right and Left still capable of offering a choice?     

Let us begin with the subjects which are not within government’s powers to decide and where, being unable to differentiate themselves, ruling parties are condemned to suffer buffeting from hostile forces: monetary policy, the rules governing public finances, trade policy, competition, financial regulation, to mention only the main ones. These are no trifles. In the knowledge that they are powerless to influence these factors, politicians are tempted by posturing - which only weakens their credibility. Rather, what is needed is a structured political debate at EU level. It is high time that politicians realise that maintaining European parties in an ectoplasmic state is not in their own interest. This argument applies particularly to the responses to the Eurozone crisis. Crucial choices lie ahead as regards the fiscal compact, the next EU budget and Eurobonds, which would deserve to be addressed in the open.           

Next comes the area of constrained choices, starting with national budgetary policy. Under the pressure of markets and with the tougher European rules, any incoming government must aim to eliminate the deficit over the next parliamentary term. This does not imply, however, that the policies to achieve this must be identical: there is a margin for differentiation on the speed and modalities of budgetary retrenchment, on the balance between increasing taxes and cutting spending, and on the choice of spending items to cut and taxes to rise. It is up to the politicians make sense of these choices and offer the voters a alternative between two versions of identically rigorous policies.    

This same largely applies to another traditional dividing-line, that between capital and labour. In all countries whose competitiveness has deteriorated the return on investment in the domestic traded-goods sector is currently too low to trigger a recovery in exports and manufacturing jobs. Governments therefore need to take measures to make business profitable again. That, however, leaves the choice of tools – tax policy or wage policy, targeted or across-the-board measures, incentives to move up the quality ladder or to preserve low-skilled jobs. As long as politicians do not stick to outdated arguments, there is genuine room for debate here.    

Finally, there is still a ‘freestyle’ policy area. Against a backdrop of global widening of inequalities between the upper one percent and the other ninety-nine, the most prominent is certainly personal taxation. It is becoming an issue everywhere and should help taxation take centre-stage in the coming elections. There is however a whole range of other issues for differentiation, such as the labour market, education or energy, to name just a few.                 

The next country where candidates will have to test the attractiveness of their proposals is France. There is widespread perception in the country that François Hollande, on the Left, and Nicolas Sarkozy, on the Right, both represent variants of the same system, and a large fraction of the voters is tempted by anti-system candidates. But it is up to the two main candidates to offer voters a choice between two different analyses of the situation, and two sets of solutions. The real risk for democracy is not that the situation is narrowing the scope for political choice. It is that politicians are loath to speak out clearly for fear of stirring dissent in their own ranks. If tactics do cause ambiguity to prevail, then one will indeed be right to say that politics will have been in suspended animation during the elections. Democracy deserves better.   

 

Post based on a column for Le Monde and published on the Bruegel blog in January 23, 2012

The Eurozone’s gamble

For the third year in a row, the Eurozone is the weak spot of the world economy and the focus of international attention. In 2010 discussions concentrated on responses to the crisis in the periphery –Greece, Portugal and Ireland. In 2011 the crisis moved to the core as Italy and Spain felt the heat, and there were mounting concerns about the viability of the Eurozone. The question for 2012 is whether tensions are going to abate or reach a new climax.

In the eyes of many, the Greek crisis still epitomises Europe’s failings. The Europeans should indeed take the blame for their delayed, hesitant and often contradictory handling of it. In the coming weeks, hard decisions will again have to be made about debt restructuring and the provision of further assistance. Once again, the Europeans will have to accept that the situation is more serious than they thought and they will agonise over choices between alternative evils. Once again, the handling of the Greek crisis will be of significant consequences for the rest of the Eurozone. And the situation could even get worse in the months to come. But the depth of its woes should not hide that Greece is a very small economy and in many respects an extreme, special case. No other country flouted the rules the way it did and has accumulated so much public debt, and no other country combines to the same extent a dysfunctional state and an uncompetitive private economy.

The really significant battle is being fought in Spain and Italy. Those are two large economies accounting respectively for 11% and 17% of the GDP of the Eurozone. Both have seen their borrowing conditions deteriorate in the second half of 2011. Both as so large that taking them out of the market and financing them through multilateral assistance would strain, if not exhaust, the resources of the Eurozone and the IMF. Both have recently changed government and have put in place a new, reform-minded team. Both are struggling to rebuild competitiveness, foster growth, restore public finance soundness and clean up bank balance sheets. If they succeed the euro will survive. If they fail it won’t, at least in its present form.

Implicitly at least, discussions over the last few months have largely been about how to support adjustment and reform in Spain and Italy. Proposals to let the European Central Bank intervene more decisively on the bond markets, or to increase the size of the ‘firewall’ through leveraging the European financial facility, were intended to set an upper limit to interest rates paid by Spain and Italy on their debt issuance. Similarly, proposals to create common bonds were intended to quell expectations of insolvency through ensuring that these countries will eventually be able to borrow with the guarantee of their partners. All the discussions were couched in general terms but everybody had the same specific countries in mind.

It is now likely that none of these proposals will be implemented in the months to come. The ECB has bought some Italian and Spanish bonds and it may buy more, but has made clear that it is not ready to commit to a ceiling for long-term interest rates. The size of the financial facility (the EFSF) will be increased through bringing forward the creation of the permanent European Stability Mechanism (ESM) and by letting it overlap with the EFSF, but its capacity will remain limited at about €500bn, clearly below the trillion-plus envisaged by the advocates of the bazooka solution. And Eurobonds are officially off the agenda, at least for the time being. Rather, Europe is putting in place a new fiscal compact to ensure that all countries in the Eurozone implement stringent budgetary adjustments.

A reason for these choices is that all the financial engineering schemes imagined to protect Spain and Italy from aggravated borrowing conditions raise legal, political or governance difficulties. But there is also a deeper logic behind their rejection: it is thought that protection from market pressure would only slow down adjustment and reform. The perception in Northern Europe, especially in Berlin, is that only serious strains provide the required incentives to overcome domestic political and social obstacles to slashing public spending and reforming labour markets. The view is that in order for Southern Europe to take action, it needs to feel the pain. A deep recession and a sharp increase in unemployment may well be the price to pay for lasting improvements.

This reasoning is not without justification. Soon after the ECB started buying Italian bonds last august, the coalition of then-Prime minister Silvio Berlusconi backtracked on its commitments to tax reform. Even though its stance was later reversed, the episode was widely regarded as prima facie evidence of the moral hazard effect of ECB support. It took a worsening of the situation of the bond market for the coalition to fall and for Berlusconi to be replaced by the reform-minded Mario Monti.

But the strategy is also a high-risk gamble. Governments may need incentives to act, but they also need to be able to show their citizens that reform pay off. If after a few quarters of fiscal adjustment and painful reform output is lower, unemployment higher, and the outlook darker than before governments may soon lose the support of the population and reform may stall, as we have seen in Greece. Reform-minded teams may lose power to populist ones. Furthermore, a deteriorated macroeconomic and financial environment increases risks of bank failures, with immediate consequences for public finances and economic confidence. These risks are compounded by the simultaneity of such adjustments in several countries. True, competition for performance is an incentive to act. But macroeconomic and financial interdependence is also at work and it may render success more elusive.

Europe has therefore made a choice, but it has also embarked on a risky strategy. Because one thing is to consider that governments only act under pressure and that societies only accept reforms if they perceive them as without alternative, and another is to hope that adjustment and reform will proceed if the whole of Southern Europe is struggling with recession. The strategy of keeping Southern Europe on a short leash would be much more credible if accompanied by a growth programme for the Eurozone as a whole. Such a programme remains to be designed.

 

Column for Century Weekly (Beijing), 12 January 2011

 

Will Europe's crisis reconcile Asia with the IMF

There is something very awkward in the idea that still-poor Asia will help rescue the still-rich euro area. Asia remembers very well that when in trouble in the late 1990s, it was ruthlessly advised to turn to the International Monetary Fund.

Yet it may happen. Europe is bound by an extraordinary series of self-imposed constraints – no common taxation, no mutual guarantees, no monetary financing, to name the main ones – and European countries have now pledged to contribute to the IMF so that it can intervene in Europe. The desire for matching contributions from the rest of the world was unequivocally expressed by the European leaders on 9 December. The questions are: should Asia follow suit, and what would be the consequences?

Asia has two reasons to offer such support: to protect itself from Europe, and to protect itself from the US.

In the short term, the fallout in Asia of a further aggravation of the European crisis would be serious. This is partly because Europe is a large export market but also because European banks are big players in Singapore and Hong Kong, as well as major providers of trade finance. The IMF’s Spillover Report reckons that through these channels financial stress in Europe could seriously dent Asian growth. 

In the medium term, financial turmoil in Europe would also deprive China and the rest of Asia from an important hedge against a depreciation of the US dollar. Furthermore, before the outbreak of the crisis, the euro was a successful regional currency en route to becoming the second global currency. For those in Asia who believe that the world’s natural evolution is towards a multipolar global economy, it provided a natural building block for a multipolar currency system. Should it disappear, the transition to a multi-currency system would be lengthier and bumpier.

But Asia does not trust Europe enough to invest much directly, so it is likely to opt for the detour through Washington. The IMF is certainly still viewed with much suspicion in Asia, where its failings in Indonesia or Korea are vividly remembered. But at least it is equipped with a governance system in which Asia has a voice, and is bound to gain weight faster if it becomes a major contributor.  

It may well take a European crisis to reconcile Asia with the IMF. And ironically, we may well soon be hearing Asians lecturing Europe on the need to turn to the Fund.

 

Column for The Financial Times' A-List blog, published on December 19, 2011

Should Asia help Europe?

There is undoubtedly something shocking in the idea that Asia should help rescue the euro area. Europe is remarkably rich by world standards – and not only in income terms. According to data compiled by McKinsey it accounts for 30 per cent of the global financial market, against 12 per cent for Japan and less than 8 per cent for China. It may seem strange to wonder whether it can rescue itself without a helping hand from distant, and in the case of China considerably less wealthy countries. Furthermore, Asia remembers that Europe’s advice at the time of the Asian crisis in the late 1990s was (except for a limited direct assistance to Korea) to turn to the International Monetary Fund, whose intervention was a trauma for the region.     

Nevertheless, Europe’s leader at their latest meeting on 9 December December declared that in parallel to the resources they are themselves channelling to the IMF through their central banks (in order for the Fund to step up its support to the euro area) they were “looking forward to parallel contributions from the international community”. A few days earlier, the euro area’s finance ministers had indicated support to the creation of one of several co-investment funds that would attract capital and enhance the capacity of their financial assistance arm, the European Financial Stability Facility, the EFSF. 

So why is Europe asking for support? And are there good reasons for Asia to respond?

On the receiver’s side, the sad truth is that Europe is bound by an extraordinary series of constraints. First, the EU and the euro area do not have taxing power. For this reason they cannot borrow against the promise of future tax receipts. Second, the euro-area member states have not really pooled their resources. The EFSF relies on guarantees provided by individual member states up to a pre-set limit and though the set-up is different, limitations also apply to its future successor the European Stability Mechanism (ESM). Third, the European Central Bank (ECB), which as a central bank can create money at will, is uncomfortable with the idea of doing it to purchase bonds issued by national governments. As long as these constraints prevail, fiscal resources are scarce and monetary resources barely available. This is what has made problems of limited size – Greece, Ireland, Portugal – or seriousness – Italy, Spain – less tractable than they should be.

From an Asian perspective, things are evidently different. Europe’s self-imposed constraints are no argument for providing help. What matters rather is Asia’s own interest. In this perspective, however, there are two reasons why contributing may be a rational choice.

The first reason is that the fallout from the euro crisis is far from trivial. This is not only because a European recession immediately affects Asia through demand channels, as experienced in 2009 when global trade contracted sharply, but also because of financial linkages. The euro-area Spillover Report released by the IMF last summer shows that in addition, adverse effects from financial strains in the European banking sector could be even more significant. In recent years, European banks were very active globally in the financing of the international dollar-denominated trade and they also have subsidiaries and assets in Asia. Their current state of stress leads them to curtail credit and deleverage aggressively, with serious consequences for Asia. Taking into account these linkages, the IMF has produced illustrative, but frightening enough numbers: in a stress scenario that sees growth in the euro area decline by 1.3 percentage point, Asian growth declines by 0.4 percentage point. Helping Europe to overcome this crisis would therefore do good to Asia.

The second reason for Asia to support is that the euro remains for the time being the only possible alternative to the US dollar. Before the outbreak of the crisis it was a successful regional currency, reaching out beyond its borders, and it was widely seen as en route to becoming a second global currency. The euro was providing a partial investment alternative to the US dollar, therefore a hedge against dollar depreciation. For those in Asia who believe that the world’s natural evolution is towards a multipolar global economy, it provided also a natural building block for a multipolar currency system comprising at least the dollar, the euro and the renminbi. Should it disappear, the transition to a multi-currency system would probably be lengthier, and also less smooth.                

There are therefore both short-term and longer-term motives for an Asian support to the euro area. The best way to do it would be for Asian investors to buy euro-area bonds. In principle, these may after all be a better investment than currently feared. In spite of the series of constraints Europe has created for itself the euro area’s aggregate budgetary situation is certainly not worse than that of the advanced economies taken as a group. However the euro area does not offer, at least for the time being, Eurobonds benefitting from the joint and several guarantees from all its members. The investment vehicle it is planning to offer does not have the certainty and the durability Eurobonds would presumably have. So investment options are still largely limited to national bonds.

Beside investment, the alternative is to lend to the International Monetary Fund as suggested to the European leaders, thereby providing the resources the Fund could need for large-scale European operations. Ad-hoc arrangements with groups of creditors have been entered into in the past and they have the advantage of not implying that all Fund members participate.

The IMF is certainly still looked at with suspicion in Asia, where its failings at the time of the Asian crisis are still vividly remembered. But at least, it is an international institution equipped with a governance system where Asia has a voice (and could hope to increase it faster if it becomes a major contributor). From the lender’s perspective, channelling resources through the Fund could therefore be a better alternative than direct lending.

Ironically, it may take a European crisis to reconcile Asia with the IMF.        

 

Column for Century Weekly, December 2011

 

La zone euro et le syndrome du réverbère

On ne peut plus les accuser de déni : ils sont très conscients des risques qui pèsent sur leur monnaie et leurs économies. Ni de pusillanimité : ils envisagent ce qu’ils s’étaient juré d’éviter, une modification des traités. Ni même d’inertie : ils veulent se voir tous les mois. La question est de savoir s’ils partent du bon diagnostic. A lire la lettre conjointe d’Angela Merkel et Nicolas Sarkozy, il est permis d’en douter.

Commençons par reconnaître le positif : une gouvernance plus ferme de la zone euro, la création accélérée du Mécanisme de Stabilité (MSE), en complément de la facilité financière (FESF) déjà en place, et qui est appelé à jouer le rôle d’un FMI européen ; une approche plus décentralisée de la responsabilité budgétaire, avec des règles et procédures nationales de type « règle d’or » ; et l’esquisse d’un accord tacite avec la BCE. Tout cela est bienvenu.

Ce qui fait problème, en revanche, est l’hypothèse contestable selon laquelle les problèmes de la zone euro viennent essentiellement d’un manque de respect des disciplines du Pacte de stabilité.

Personne, évidemment, ne peut contester la nécessité de corriger les défauts d’application du Pacte et d’empêcher la répétition de ce qui s’est passé en 2003, lorsque France et Allemagne ont fait alliance pour bloquer les procédures et écarter toute menace de sanction à leur encontre. Mais ces réformes ont déjà été décidées dans le cadre de la législation dite du « pack de six » qui entrera en application en janvier. Y revenir une fois de plus, en insistant sur le seuil de 3% et l’automaticité des sanctions relève du tristement célèbre syndrome du réverbère, qui conduit à chercher ses clef sous la lampe, plutôt que là où il fait noir. Pour trois raisons.    

La première est que le Pacte de stabilité souffre de défauts de conception au moins autant que d’application. L’Irlande en 2007 était en équilibre budgétaire, l’Espagne enregistrait un excédent de deux points de PIB. Quatre ans après, fin 2011, la dette de l’Irlande est passée de 25% à 108% du PIB, celle de l’Espagne de 40% à 70%. Des recettes fiscales artificiellement gonflées par le boom de la consommation et de l’immobilier donnaient l’apparence d’une situation saine, elles se sont effondrées dès que la bulle a crevé. Et surtout, les Etats ont dû renflouer les banques, pour un coût évalué à 40% du PIB dans le cas irlandais. Ce n’est ni par la sanctification de la norme des 3 pour cent ni par l’automaticité des sanctions qu’on préviendra pareils sinistres à l’avenir, c’est au contraire par une approche plus fine et plus discrétionnaire.

La deuxième raison tient à l’interaction perverse entre crise souveraine et crise bancaire. Parfois, comme en Irlande, c’est la faillite des banques qui a mis les Etats à genoux. Parfois, comme en Grèce, c’est la faillite de l’Etat qui menace les banques. Partout, c’est le même cercle vicieux : Etats et banques s’affaiblissent mutuellement, parce que les bilans des banques sont chargés de titres de dette de leur propre souverain et que celui-ci est porte seul la charge d’un éventuel sauvetage des établissements financiers. Aux Etats-Unis, les banques détiennent peu de titres publics, et quand elles en détiennent ce sont des titres fédéraux ; c’est aussi à l’Etat fédéral, pas l’Etat de New York, qu’incombe un éventuel sauvetage des banques de Wall Street.

Pour mettre fin à cette interaction qui fragilise toute la zone euro, il faudrait obliger les banques à diversifier leurs risques ou leur offrir des titres représentatifs de l’ensemble de la zone (les fameux Eurobonds) ; il faudrait aussi transférer au niveau européen la responsabilité de la supervision des grandes banques et mutualiser la charge d’un éventuel renflouement, ou doter à cette fin la zone d’une capacité fiscale. Sur ce plan, cependant, rien de sérieux n’a encore été fait, si ce n’est de faire peur aux banques en leur demandant de valoriser leurs obligations d’Etat au prix du marché, donc avec une décote pour tous les titres d’Europe du Sud. Le résultat est qu’elles allègent précipitamment leurs portefeuilles, ce qui décote encore plus les titres correspondants.

La troisième raison est que l’euro souffre autant d’une crise de balance des paiements que d’une crise budgétaire. C’est l’analyse que développe à juste titre Martin Wolf dans ces colonnes. Depuis 2007, le capital privé a graduellement cessé de financer les pays d’Europe du Sud, et les banques centrales ont dû se substituer à lui. Cette situation est dangereuse. On croyait que les balances des paiements disparaîtraient entre pays de l’euro, elles existent toujours parce que la mobilité est faible et que les banques restent nationales. Résoudre ce problème au fond appelle une intégration plus poussée. Ce n’est pas la voie qui est prise.

 

Chronique publiée dans Le Monde du 13 décembre 2011

The eurozone and the streetlamp syndrome

The world was looking for a watershed in Europe. There was one at the European summit last week, but not the one expected: Britain’s isolation on treaty reform was a defining event for the future of Europe, but the agreement to rescue the euro fell short of setting the foundations for stability and growth in the euro area.   

Let us begin by acknowledging two positives in the euro decisions. First, there will be significant ammunition at the disposal of the firefighters: the swifter introduction of the European Stability Mechanism (ESM), its temporary coupling with the financial facility (EFSF) already in place, and new resources to the IMF (which are certainly going to be matched by contributions from the emerging world) add up to a serious intervention power. Markets are likely to take notice. Second, there is new emphasis on a more decentralised approach to budgetary responsibility, with national rules and procedures of the ‘golden rule’ kind. If properly designed and seriously implemented, tailor-made provisions for fiscal discipline are likely to be more effective than micromanagement from Brussels. The new set-up may gradually change the role of the EU, from an intrusive yet ineffective watchdog to a guardian of the consistency of national rules. All this is welcome.   

There is a snag, however: the questionable premise that strict enforcement of the disciplines of the Stability Pact is the key remedy to the euro area’s problems.  

No one can argue about the need to correct the faulty implementation of the Pact and to prevent a repetition of what occurred in 2003 when France and Germany combined forces to block the procedure. But these reforms have already been decided and will enter into force in January. Returning once more and underlining the importance of the three-percent limit and automatic sanctions resembles the famous ‘streetlamp syndrome’, whereby one looks for lost house keys in the light of the lamp rather than elsewhere where it is dark. For three reasons.       

The first is that the Stability Pact suffered from design faults as much as faulty implementation. In 2007 Ireland had a balanced budget and Spain had a significant surplus. Four years later, at the end of 2011, Ireland’s debt has risen from 25 percent to 108 percent of GDP, and that of Spain from 40 percent to 70 percent. Tax receipts artificially swollen by the domestic demand boom made the situation appear healthy but they evaporated as soon as the bubble burst. And governments have had to refloat the banks, at a cost estimated at 40 percent of GDP for Ireland. No amount of automaticity will prevent damage such as this in the future. On the contrary, what is needed is a more economic, rather than legal, and a more discretionary approach.     

The second reason is related to the perverse interaction between the sovereign and bank crises. In some case, such as Ireland, it is the collapse of the banks which brought the country to its knees. In others, as in Greece, it is the failure of the state which is threatening the banks. The same vicious circle applies everywhere: sovereigns and banks are weakening each other because the banks’ balance-sheets are loaded with the debt of their own government and the government alone bears the burden of any rescue of financial institutions.  In the US banks hold little government debt, and when they do it is federal debt. And it is also to the federal level, not New York state level, that Wall Street banks would look for rescue.  

In order to put a stop to this interplay which is making the whole of the eurozone fragile, banks must be required to diversify their risk, or be offered paper representing the whole of the euro area (the famous Eurobonds). Responsibility must also be switched to euro-area level for supervising big banks and the burden of cash injections partially mutualised, or the area must be endowed with fiscal powers to this end. However, nothing serious has been done here, other than scaring banks by asking them to mark government bonds to market, in other words to mark down all southern European paper. The upshot is that banks are offloading these bonds in a hurry, which is knocking even more value off them.     

The third reason is that the euro is suffering as much from a balance-of-payments crisis as from a budgetary crisis, as Hans-Werner Sinn and others have emphasised. Since 2007 private capital has gradually stopped financing southern European countries and central banks have had to step in instead. This situation is dangerous. It was believed that the difference in balance of payments would disappear between euro countries, but they still exist because mobility is weak and banks remain national. To resolve this problem at its root calls for deeper economic integration. This is not the path being adopted.            

If the drug works, it will be because the dose is massive. But the leaders’ prescription is no precision medicine, to say the least.

 

Column for Handelsblatt published on November 23, 2011

 

The Making of International Monetary Reform

If French President Nicolas Sarkozy had written the prologue to his presidency of the G-20, which just commenced, he could not have done better. The run-up to the G-20 summit in Seoul was marred by a series of currency controversies, bringing international monetary reform to the fore. Whereas French intentions to reform the international monetary system had initially been received skeptically, suddenly reform looks like the right priority at the right time.

The task is anything but simple. The subject is abstruse. No one outside academia has taken any interest in it for the last 20 years. Accordingly, there are hardly any comprehensive proposals on the table.

The United States, for which international monetary reform is synonymous with diminution of the dollar’s global role, is lukewarm. China, which launched the idea, is happy to see the discussion gaining momentum, but lacks precise ideas. As time is on its side, it sees no reason to hurry.

Emerging countries hold a similar opinion: they want their current problems to be solved but are not ready to re-write the rules of the game. Japan is keen, but its views on regional monetary cooperation do not match China’s. And Europe is distracted more than ever with its internal crises.

Nevertheless, international monetary reform remains a legitimate aspiration. As Vladimir Lenin once reputedly put it, “the surest way to destroy the capitalist system [is] to debauch its currency.” This applies to the world economy today.

When the rules of the global monetary game are unclear, inadequate, or obsolete, countries cannot abide by them, and some may attempt to exploit them to their own advantage. This undermines the fabric of international economic relations. 

The agenda for reform boils down to four key problems. The first is exchange-rate relationships. Developed countries’ currencies have been floating against each other for several decades, but this has been only partly true of emerging and developing countries. Many, especially in Asia and the Persian Gulf, are de facto linked to the dollar, others to the euro.

But fixed exchange rates often lead to undervaluation (as in China) or overvaluation (as in Argentina at the beginning of the 2000’s, and, in a different context, several eurozone countries now). And floating and fixed exchange-rate regimes coexist uneasily, because volatility tends to affect the floating currencies (often the euro, and recently the Latin American currencies).

So the system needs a reshuffle. The touchstone is currently the renminbi – not so much because of China’s bilateral relationship with the US, but because other emerging and developing countries monitor the renminbi-dollar exchange rate for setting their own policy. China knows that the current situation is not sustainable, but it remains reluctant to move aggressively to let the renminbi strengthen.

The second problem is imposing discipline on national policies in order to preempt the temptation to export domestic inflation or unemployment. Under the gold standard, discipline was automatic. With floating exchange rates, it is not.

According to an unwritten rule that has emerged over the years, central banks can do as they see fit, given that they keep inflation stable over the medium term. This rule normally ensures a modicum of coherence and avoids overreactions in exchange rates, but it is insufficient in deflationary times.

The US Federal Reserve argues, with some justification, that its quantitative easing is compatible with price stability, while Europe and several emerging countries deem it beggar-thy-neighbor behavior. The problem is that the current context provides no yardstick for assessing when a national policy stops being cooperative.

So we need what the jargon calls “surveillance.” This is the International Monetary Fund’s role, but the IMF’s mandate is just that – surveillance, not enforcement. It is also the G-20’s role, but neither the US nor the emerging countries are keen on collective constraints.

The third problem concerns international liquidity. Financial flows are excessively volatile. Emerging countries are inundated with capital inflows one day, and faced with abrupt and equally destabilizing outflows the next.

To prevent their currencies from appreciating too much in the first case and falling too far in the second, emerging countries have accumulated foreign-exchange reserves, two-thirds of which are denominated in dollars. These reserves now amount to 15% of global GDP, compared to 6% ten years ago. Ultimately, whether this is due to self-insurance or to exchange-rate targeting matters little: this unproductive growth in reserves was yesterday an indirect cause of the crisis, today it is undermining demand.

The goal should be to make self-insurance unnecessary by guaranteeing access to international credit lines in case of abrupt outflows of private capital. The IMF started to do this when it created credit facilities without the Fund’s usual (and humiliating) conditionality. But suspicion of the IMF persists, and most countries, especially in Asia, still prefer costly self-insurance to a form of mutualization perceived as uncertain.

The fourth problem is collective anchoring. Naturally, the major central banks are concerned with the inflation that they can control – homemade inflation. But this neglects global inflation driven by rising commodity prices, which has been increasingly evident.

This was not an issue in the disinflationary environment of the last decade, but it is becoming more of one. Hence probably World Bank President Robert Zoellick’s proposal to restore a role for gold. The notion is absurd – Keynes long ago spoke of gold as a “barbarous relic” – but the problem of anchoring global monetary policy and ensuring its alignment with developments in global supply is nonetheless real.

The Nobel laureate economist Robert Mundell once compared a monetary regime to a political constitution, because it establishes the rules of the game. The analogy is apt. Unfortunately, it also indicates how ambitious and challenging a task it is to reform the international monetary order.

 

Column for Project Syndicate, December 3, 2011

Don’t admit defeat – fiscal union can still work

Markets are increasingly nervous and risks for the eurozone are escalating. Europe’s leaders may still harbour secret hopes that the European Central Bank will come to their rescue, but at least they seem to have understood that the surest way to make that happen is to deliver on what they have responsibility for, starting with budgets. Fiscal union is now officially on the European agenda in the run-up to the last European summit of the year on December 9.

For some, this is all about strengthening sanctions for budgetary slippages through more automatic decision procedures and granting the power to veto national budgets to a European body. Angela Merkel, the German chancellor, has spoken along these lines recently. Mark Rutte, the Dutch prime minister, is on a similar page. However, this plan alone is likely to be resisted and in the end, it is not likely to deliver much more than another layer of half measures.

The principle underpinning budgetary surveillance is that each country is solely responsible for its own debt, but that it can be sanctioned after the event for misbehaviour. Alternatively, countries participating in the eurozone could have joint responsibility over at least part of their public debt, but they would also agree to give their partners the right to veto their budgets before they are implemented. To be clear, this would imply that eurozone members agree to provide a guarantee to the holders of, say, Italian debt and have the right to prevent the issuance of Italian debt.

Both principles are logically consistent. The choice today is whether to move towards adopting the latter instead of the former. But the idea of introducing a veto procedure without anything in return is a dream. The unilateral surrender of budgetary sovereignty – a fundamental parliamentary right – is not something democratic countries will easily agree to if they do not get anything in exchange.

This is why, if serious, the debate on fiscal union is bound to involve discussion about the issuance of eurozone bonds. However, these come in many different shapes and colours. The European Commission has presented a number of proposals. The German Council of Economic Experts also suggested its own version.

Ideally, the scheme for issuing eurozone bonds would ensure that in order to be attractive to overseas investors they are at least as safe as and more liquid than existing high-quality government bonds. It should also involve incentives to fiscal discipline so that participating governments contribute to keeping the new bonds on a sound footing. In view of these criteria, the incentives-focused “blue bond” proposal by Jacques Delpla andJakob von Weizsäcker remains the best on offer.

However, recent developments at the German constitutional court complicate matters. The court has ruled that Germany cannot enter into unlimited, open-ended commitments vis à vis partners.

The German experts’ proposal addresses these concerns by proposing a temporary guarantee scheme covering current debt in excess of 60 per cent of gross domestic product. They envisage the creation of a temporary redemption fund that would benefit from joint and several liability and through which participating countries could issue debt in the next few years until they have reached their quota (namely, their current debt less 60 per cent). This debt would be paid off and gradually extinguished over time. To this end, each participating country would be required to earmark specific tax revenues.

There are shortcomings in this proposal. One may wonder what would be the attractiveness of temporary eurozone bonds. Countries with high debt, such as Italy, would benefit from it more than those with low debt, such as Spain, though the scheme could be tweaked to correct this imbalance. It would also lack the permanent incentive property of the blue bond scheme. But it has two advantages. First, the temporary possibility to issue new debt under joint and several liability would give breathing space to countries in trouble, leaving them time to adjust. Second, it would be an instrument to rebuild trust among the members of the euro area. For these two reasons, it deserves serious consideration.

 

Column for The Financial Times' A-List blog, published on November 28, 2011

Germany’s hour

A series of events over the last few weeks have created a new situation in Europe.

First, the euro area has failed to turn the tide. Mario Draghi was right to note last week that in spite of numerous ministerial meetings and three summits, implementation of the decision taken in July is still lacking. There are by now growing doubts about the very wisdom of holding them.

Second, and partially as a consequence, the debt of virtually all euro-area countries is trading at a discount to the German Bund. While a more accurate pricing of risk was necessary, it is hard to believe that with a debt ratio nearly twenty percentage points lower, the Netherlands deserves to be assessed more prone to default than Germany. Even the Bund started to suffer from market anxiety last week.

Third, market participants and, increasingly, real businesses are pricing in a break-up scenario. It is still hard to think the unthinkable, let alone to work out the details of it, but any rational player has to consider the possibility of it. If disaster expectations build up and a growing number of players start positioning themselves to protect themselves from it, the consequences could become overwhelming.   

Fourth, Germany has become the undisputed leader of the euro area. Although France continues to play its role in the couple, it has lost weight and initiative. A weaker French economy, weaker public finances and the coming presidential election are all combining to alter the balance in the old couple. Political impetus can defy the laws of gravity, but only up to a point.

In this context Germany finds itself again in a situation akin that of the late 1980s, when the Bundesbank was making monetary policy for the rest of the continent. At that time chancellor Kohl wisely assessed that German economic dominance was not a stable equilibrium and that a better plan for the future was to build on Germany’s weight and influence to create a permanent common monetary order. This is what gave birth to the euro.                 

Today again Germany’s best interest is to ensure lasting stability in Europe. With foreign assets worth 6 trillion euros, most of which consist of claims on euro-area partners, Germany would lose out massively in a fragmentation of the euro area. Claims on entities in partner countries would either be redenominated in weaker currencies or the borrowers would default on them. And, obviously, German exporters would be hurt by substantial currency appreciation.

Chancellor Merkel has sensibly decided to take the lead on reforming the euro area. But many Germans feel deceived by irresponsible euro-area partners. There is therefore the temptation to use Berlin’s current strength to toughen sanctions and coerce weaker partners into adopting constitutional changes, especially in the budgetary field.

This is a risky attitude. For sure, Germany today has far more leverage than it has had at any point in the last twenty years. But to attempt to extract unilateral concessions from partners is a recipe for disappointment. It is one thing is to be sanctioned if you breach the rules, as today with the Stability and Growth Pact, and quite another thing to move to a new system that gives a higher-level authority the power to overrule national parliaments and censor a budget before it is enacted. Partners are unlikely to agree on major reform if Germany does not offer something in exchange. What is likely to emerge from negotiations is, rather, another layer of largely ineffectual sanctions procedures.

The natural quid-pro-quo for ex-ante budgetary control is solidarity through the creation of Eurobonds. Joint and several liability over public bonds is imaginable only if countries offering their guarantee – in effect potential access to their taxpayers – can exercise veto power and prevent a partner country from issuing more debt. So legally binding ex-ante control is a sine-qua-non condition for Eurobonds. Symmetrically, surrender of budgetary sovereignty through the granting of veto power to the partners is acceptable only if it comes in exchange for a guarantee from these partners that they will come to the rescue in case of accident.

Germany therefore should be bold and use its leverage to offer a new contract to its euro-area partners: mutual guarantee over part of public debt in exchange for strict debt limits and a new legal order in the framework of which a euro-area authority could veto a budget passed by a national parliament even before it starts being implemented. Only boldness will deliver.

 

Column for Handelsblatt and Project Syndicate, November 23, 2011

Is QE2 beggar-thy-neighbour?

Whatever the US domestic debate, the rest of the world is highly doubtful about QE2. The Europeans have been especially vocal but many in the emerging world are also fearful of its consequences. The question is, can QE2 be characterised as beggar-thy-neighbour?

In his recent speech at the ECB, Ben Bernanke said that asset purchases by the Fed are only the continuation of conventional monetary policy by other means, the difference being that they affect interest rates of securities on longer maturities whereas conventional monetary policy primarily affects the short end of the yield curve. If this definition is accepted, then it follows that the criterion for determining whether QE can be considered beggar-thy-neighbour is the same than for conventional monetary policy. 

There is no explicit criterion for assessing the cooperative character of monetary policy and resulting exchange rate developments. There was one in the post-war fixed exchange-rate regime as currency devaluation was subject to the IMF and to the partner’s scrutiny. There was one also in the target zones system of the late 1980s-early 1990s. But no such criterion exists in a floating exchange rate regime based on the principle of monetary policy autonomy.

An implicit criterion however has emerged from the central banks’ practice of the last two decades: as long as monetary policy remained geared towards price stability as usually defined – say, an inflation objective in the 1-3 per cent range – it has been generally assessed in line with the requirements, or at least the spirit of international cooperation.

If this implicit criterion is also accepted the question at the present juncture is twofold:

• First, what does this definition become in a context where inflation objectives are frequently undershot? If the inflation objective is, say, 2 per cent, but actual inflation 1 per cent for an extended period of time because of the extent of economic slack one central bank (say, the ECB) may conclude that it has to accept that it is temporarily unable to reach its objective whereas the other one (say, the Fed) may conclude that it needs to commit even more strongly to reaching it, possibly by adopting a price level instead of a price change target. This would lead to significant monetary policy divergence with immediate consequences for the exchange rate (even if these consequences would be offset in the medium term by inflation differentials). This is entirely a monetary policy issue that arises from the lack of a commonly agreed definition of cooperative policy in a deflationary environment.
• Second, is monetary policy geared towards price stability in the medium run? This essentially boils down to determining whether there is a risk of fiscal dominance, i.e. of an unsustainable fiscal policy ultimately leading to an irresistible pressure to monetise the public debt. The problem here is not directly the monetary policy stance, rather the sustainability of it in the absence of a framework guaranteeing fiscal discipline.     

The exchange-rate consequences of different monetary policy attitudes in a deflationary context are not trivial but not significant either. They may drive a temporary depreciation of the dollar exchange rate vis-à-vis the euro, but they are unlikely to result in major misalignments. Furthermore, risks can be limited by discussions among central banks on the interpretation of their price stability mandate in a deflationary context.

But the consequences of an expectation of debt monetisation can be much more severe. In Europe, all governments have announced plans to restore budgetary sustainability. In the US, partisan strife over budgetary policy leads to fear that the Federal Reserve will ultimately have to inflate the problem away. Recent reactions to the Simpson-Bowles and Domenici-Rivlin proposals suggest that the US has got perilously close to the ‘war of attrition’ situation once described by Alberto Alesina and Alan Drazen. This, more than the Fed’s stance, is the real danger.

 

Contribution to the Economics by Invitation blog, November 21, 2011

Fiscal consolidation is no indiscriminate belt-tightening

In June it was Greece. In August it was France, Italy, Spain and Portugal. In September it was Greece and, once again, Spain. In November, France again. Now Italy. Soon very likely Belgium. And perhaps France for a third time. In spite of an ever-darker economic outlook, every month European countries put under pressure by the bond markets are announcing new budget restrictions in the hope of limiting their deficits and halting the slippage in their borrowing terms. Only Germany stands out, announcing a tax cut, though a modest one.

In countries under IMF/EU programme, austerity at the very moment the economy is suffering from a severe downturn raises familiar questions about the design of adjustment packages. For them, the dilemma is a difficult one to which they is hardly a good solution: they have lost access to capital markets and need to reach primary balance expeditiously, but fiscal contraction is adding to their woes. For other countries the reason for the move is the widening of interest-rate spreads in the eurozone. While the yield on German ten-year debt remains under two percent, it exceeds three percent for France, is close to six percent for Spain, and Italian yields have burst through the seven-percent barrier. It looks a no-brainer: even if it dopes the risk of recession, accelerated budget cuts are preferable to a lethal surge in rates.  

The first is that a sound budget strategy should not be based on nominal deficit targets. Rather, it should imply setting a target for the outturn (deficit or surplus) under prudent economic hypotheses, establishing a tax and spend profile consistent with this projection, and then sticking to it irrespective of short-term developments. This allows the ‘automatic fiscal stabilisers’ to come into play. This strategy is not a loose one, in fact it may even be very rigorous if targets are ambitious, but it avoids amplifying cycles, especially recessionary ones. The only thing is that it requires credibility and transparent implementation so that markets trust that the government is sticking to its stated goal.         

The second factor is that headlong consolidation is not necessarily the best way to reassure markets. This is particularly clear in the case of Italy, whose deficit (four percent of GDP this year) is much below those of Spain and France. It is not the deficit which finally spooked investors and turned them off Italian bonds but a cocktail of high debt, desperately slow growth and political paralysis. In a situation like this, nibbling at the deficit is at best a sideshow. What the markets expect is the implementation of reforms designed to durably lift the rate of growth and the installing of credible economic governance in the euro zone. As political capital is scarce, governments have to choose where best to invest it – which may well be in reforms rather than additional consolidation.        

The third reason to doubt the benefit of hurried budgetary adjustments is that they generally rely on measures with immediate impact, but that are economically damaging. Governments know this only too well: according to an IMF survey of their intentions, at the end of 2010 they were pencilling in spending cuts in their medium-term programmes while preserving the most productive, such as education and infrastructure. And on the tax side they were planning to broaden the base rather than raise rates. This was very much in accordance with the policy consensus on what a growth-friendly consolidation should be.

But since the start of the summer European government have actually done the opposite. Rather than focus on spending, they have zeroed in on tax measures, for the most part increasing the rates of existing taxes. Expediency explains why they made this choice. But it is a bad choice for growth and ultimately the lasting and effective character of the consolidation. 

So what should be done? No doubt European countries need a budgetary clean-up, but this is a long-term process. Instead of making knee-jerk cuts, governments should first sit down and set precise and detailed targets for the medium term. They should also spell out what they intend to do in consequence about spending and revenue, in the least damaging possible way for growth.

Governments should then invest in the means to reestablish their credibility. Budgetary rules and institutions are a good investment in this respect. Many European countries have recently introduced domestic rules such as the German “debt brake” or the British “fiscal mandate”. Many have also given an independent institution a key role in overseeing the government’s budgetary behavior and in evaluating the consequences of its decision. For example, the UK has created an independent “Office for Budgetary Responsibility” that has no role in setting policy but has an exclusive mandate for establishing economic and budgetary forecasts. This helps strengthen the credibility of government policy.  

Finally, governments should ensure that their budget and fiscal programmes are consistent with the aim of increasing growth potential. This entails on the one hand finding the sweet spot in terms of spending cuts and tax rises and, on the other, identifying on each side of the ledger the least harmful measures over the medium term. This takes time, thought and steel. But again, it is a much better approach than to rush into hasty consolidation.

The question is, will markets be patient? As panic has set in, there is admittedly a risk they won’t wait to see results. But by the same token, they may be frightened if they see growth falter. All considered, the economically sensible strategy is worth a try. 

Column published in Handelsblatt and Century Weekly (Caixin), November 2011

Ne nous précipitons pas dans l’austérité

La Grèce en juin. La France, l’Italie, l’Espagne et le Portugal en août. La Grèce et, une fois encore, l’Espagne en septembre. A nouveau la France en novembre. Bientôt sans doute la Belgique. Et peut être, une troisième fois, la France. En dépit d’une conjoncture toujours plus sombre, les pays soumis à la pression des marchés obligataires annoncent mois après mois de nouvelles mesures de restriction budgétaire dans l’espoir de contenir leurs déficits et de limiter la dégradation de leurs conditions d’emprunt. Seule l’Allemagne se distingue avec l’annonce d’une baisse d’impôts, d’ampleur modeste. 

La raison de ce basculement dans l’austérité au moment même où la conjoncture se dégrade à nouveau est bien évidemment l’écartement des taux d’intérêt au sein de la zone euro. Si le taux des emprunts allemands à dix ans reste inférieur à 2% pour cent, il dépasse 3% pour la France, avoisine 6% pour l’Espagne, et le taux italien a franchi le seuil des 7%. Le calcul semble vite fait : même s’il augmente le risque de récession, un ajustement budgétaire accéléré est préférable à une envolée meurtrière des taux.

Parce qu’ils ont perdu l’accès au marché des capitaux, certains pays n’ont effectivement pas le choix.  Mais pour les autres, le raisonnement néglige trois facteurs.

Le premier est que la bonne stratégie budgétaire consiste à se donner un objectif de solde (déficit ou excédent) sous des hypothèses économiques prudentes, à fixer la trajectoire de dépenses et les mesures de prélèvement cohérentes avec cette projection, et ensuite à n’en pas dévier. Cela permet de laisser jouer les « stabilisateurs automatiques ». Une telle stratégie n’est pas laxiste, elle peut même être très rigoureuse, mais elle évite d’amplifier les cycles, notamment récessifs.     

Le deuxième est qu’une consolidation précipitée n’est pas nécessairement la meilleure manière de rassurer les marchés. C’est particulièrement clair dans le cas de l’Italie, dont le déficit (4% du PIB cette année) est très inférieur à ceux de l’Espagne ou de la France. Ce n’est pas lui qui a fini par alarmer les investisseurs et les a conduit à se détourner des obligations italiennes, c’est la combinaison d’une dette élevée, d’une croissance désespérément lente, et d’une paralysie politique. Dans ce contexte rogner le déficit est, au mieux, un expédient. Ce qu’attendent les marchés est, plutôt, l’engagement de réformes propres à relever durablement le rythme de croissance et la mise en place une gouvernance économique crédible de la zone euro.

La troisième raison de douter des vertus des ajustements budgétaires précipités est que ceux-ci s’opèrent généralement par le canal de mesures fiscales à rendement immédiat, qui sont économiquement pénalisantes. Les gouvernements le savent bien, d’ailleurs : fin 2010, ils envisageaient dans leurs plans de consolidation de privilégier les coupes dans les dépenses, en préservant les plus productives d’entre elles comme l’éducation ou les infrastructures, et qu’en ce qui concerne les impôts ils prévoyaient d’élargir les assiettes de prélèvement plutôt que de procéder à des hausses de taux. Mais depuis le début de l’été, ils ont fait le contraire : plutôt que sur les dépenses, ils ont joué sur les prélèvements, le plus souvent par hausse des taux des impôts existants. C’est un mauvais signal.

Que faire alors ? Il ne s’agit pas de nier la nécessité absolue d’un redressement budgétaire. Mais l’effort à conduire est de longue haleine. Au lieu d’opérer des ajustements précipités, les Etats devraient d’abord se fixer sérieusement des objectifs précis et détaillés pour le moyen terme, en explicitant ce qu’ils entendent faire sur les dépenses et sur les recettes.  

Les Etats devraient ensuite investir dans la mise en place de dispositifs propres à corriger leur défaut de crédibilité. C’était, en France, l’objet de la « règle d’or » proposée par le gouvernement, que le PS vient de rejeter sans discussion. Cette règle n’est pas la seule possible, mais il importe qu’un cadre de politique budgétaire stable et ambitieux soit adopté dès le début de la prochaine mandature, qui donne poids à l’objectif d’un retour à l’équilibre d’ici 2017.     

Ils devraient, enfin, calibrer leurs programmes budgétaires et fiscaux en cohérence avec l’objectif d’accroître le potentiel de croissance. Cela impose d’une part de trouver le dosage approprié entre coupes dans les dépenses et hausses des recettes, d’autre part de sélectionner dans chacun de ces deux volets les mesures les moins nocives pour le moyen terme. Cela demande du temps, de la méthode, et du courage. En France, il faut souhaiter que le débat présidentiel à venir soit, sur ce point, l’occasion d’une confrontation méthodique des options des candidats.

 

Chronique publiée dans Le Monde du 15 novembre 2011

Europe’s leaders must start making tough decisions

Days and nights, Europe’s leaders have discussed the minutiae of private sector involvement in the Greek debt restructuring. They have immersed themselves in financial engineering with the aim of leveraging the European financial stability facility. This is all necessary, but it’s the job of finance ministers or Treasury officials. What citizens and markets alike expect from the heads of state and government is that they do the job for which they are indispensable, and map out the political choices Europe is now screaming for.

A key reason why the eurozone is under challenge is that markets have become conscious of a fundamental weaknesses in its design. It relies on three hardly-compatible principles: national banking systems, which both finance the sovereign and rely on it as a potential backstop; states that are supposed to be solely responsible for their own debt, so that they cannot rely on partners when in trouble; and a central bank that has not been given the mandate to be a lender of last resort. This trio of principles was assessed consistent in normal times, because banks were sound and state solvency was not in doubt. But in crisis times, a perverse interaction between bank and sovereign weakness develops. And the central bank has no mandate to put a stop to it.

There are several, partially compatible ways out of this. One is to make states individually safe by going far beyond the requirements of the Maastricht treaty and bringing public debts down to levels where solvency cannot be challenged anymore. It implies decades-long austerity. Another way is to make the financial system safe by putting limits to the banks’ exposure to their sovereigns and creating a eurozone-wide deposit insurance. It implies that states renounce the convenience of having ‘their’ banks. The third way is to change the mandate of the European Central Bank. This implies breaking with the Bundesbank’s heritage and giving the ECB a governance structure adequate to a new, quasi-fiscal role. A last option is to move towards fiscal union so that individual state solvency stops being a concern for markets. It means accepting both shared responsibility over public debts and ex-ante oversight of national budgetary decisions.

Provided it is implemented consistently, each of these responses would be recognised by markets as a watershed. Each has advantages and drawbacks. Each has broader implications for Europe. Each involves risks. But a way has to be chosen. As the Pierre Mendès-France, the late French prime minister, used to say, “gouverner, c’est choisir”.

 

Column for The Financial Times' A-List blog, published on October 26, 2011