The role of central banks and governments in the crisis

Transcription

1 The role of central banks and governments in the crisis 87 th Kieler Konjunkturgespräch Kiel, March 18/ Joachim Scheide, Kiel Institute for the World Economy

2 After the synchronous downturn we now expect a recovery in the world economy 1 We saw weak growth in 2012, but recently expectations have turned around again So there is a good chance that 2013 will look better if nothing happens!!! Emerging economies are the locomotives and account for about 80 % of the growth in the world economy Advanced economies are still disappointing Some caution: So far, mainly the survey data have improved whereas the hard facts do not yet show a strong start into the year Sentiment improved thanks to good messages from policy ( fiscal cliff, Draghi s speech)???

3 IfW-Indicator and world economic activity: Some improvement since the end of Percent Index GDP Indicator (rhs)

4 IfW-Financial Market Stress Indicator for the Euro Area and for Germany: Markets have calmed down recently 6 Index Lehman Euro Area Debt crisis -1 Germany

5 4 Real GDP growth in the world economy: The two-speed recovery continues Country/Group Advanced economies United States Japan Euro Area Emerging + Dev. economies Brazil Russia India China World World trade

6 The old question for economic policy: What is the trend, and how large is the output gap? The crisis has made the estimation of the natural level of output more difficult Nevertheless, the gap is an important variable for both monetary and fiscal policy Empirical evidence says that a severe crisis has a permanent (negative) effect on output And it is likely that the trend estimated before the crisis was too optimistic because the boom was boosted by bubbles and not sustainable Another or a supporting hypothesis is that uncertainty about economic policy has an impact on the speed of the recovery 5

7 Uncertainty concerning economic policy in the US and in the Euro Area: One reason for the weak recovery? 300 Index United States Euro area

8 The current recovery in the United States: The typical growth pattern after a crisis 120 Index 115 Trend GDP

9 The current recovery in the Euro Area: Also the typical growth pattern after a crisis but with large differences between countries 120 Index Trend GDP

10 The current recovery in Spain: The country is especially hard hit by two crises 120 Index 115 Trend GDP

11 10 Uncertainty about the output gap: The case of Spain for the boom year 2005 (EU-Commission)

12 11 The same problem concerning the estimate for the NAIRU in Spain (EU-Commission)

13 Real GDP in the Euro Area : Unsustainable boom driven by bubbles in some countries France Germany Greece Ireland Italy Portugal Spain

14 Real GDP in Euro Area countries after 2008: Unavoidable correction of the misallocations. The key question: When will growth return??? France Germany Greece Ireland Italy Portugal Spain

15 Against this background: How do we judge the currently pursued monetary and fiscal policies? 14 The controversies about the correct policy are about as severe as they were in the 1970s The extreme positions are gone (one exception is Paul Krugman), and a consensus has evolved concerning policies: - Clear commitment to targets (price stability, sustainable government finances) - Rules are the best policy to reach the targets The crisis is not only, but also, due to the fact that the rules were not followed Following the consensus, we should be worried about monetary and fiscal policies!!!

16 15 Back to the 1970s? Two extreme positions

17 16 Back to the 1970s? Two extreme positions

18 Conventional monetary policy with several risks Key interest rates are near zero and negative in real terms even though we are not in a deep recession any more Remember the great deviation in the US: One factor leading to the crisis The same happened in Spain and in other European economies: The strength of the housing boom was (negatively) correlated with the real interest rate which prevailed Now the same is likely for Germany: A persistent undershooting of the Taylor rate, lasting probably 3 or 4 more years from now! 17

19 18 The famous picture of the Taylor rule and the great deviation in the US prior to the crisis

20 The Taylor rule and the interest rate in Germany: Looks like another great deviation! 6 Percent Actual rate Taylor rate Percentage points Deviation from the Taylor rate

21 Unconventional monetary policy continues on a large scale 20 The Fed s policy of quantitative easing will continue and lead to another massive increase of the balance sheet The policy of the ECB is not what we had in mind when we went for the Monetary Union: - Possibly unlimited purchases of government bonds - Regionalization of monetary policy - Balance of payments financing All this has been justified not as a solution but a way to buy time for about 5 years now Are governments using this time, or is it wasted?

22 21 The effects of QEx on reserves: Inflation and/or recession?

23 Another big risk for the world economy: High government debt The debt-to-gdp ratio of industrial countries has passed the 100 % mark This is the highest level in peacetime The problem is not limited to Europe Some countries are doing something, others don t: Cliff show in the US and a deficit of 7% Negative effects on growth likely: Work by Reinhart/Rogoff and others Vicious circle possible: High debt -> low growth -> higher debt The big risk: Surge of interest rates this also depends on the policy of central banks 22

24 Debt-to-GDP ratio in advanced economies since 1880: Record high in peacetime 140 Percent

25 Government debt in the Euro Area: Was the increase now good for growth??? 100 Percent

26 Just for fun: CBO projections for the Federal debt in the US until 2080: Scared anyone??? Percent Source: Taylor (2011) on the basis of CBO projections. 25

27 The four policy options: Have governments agreed to choose inflation? If budget consolidation in EMU does not work, there are only three options left: 1. More transfers unlikely! 2. Debt restructuring excluded by governments! (even Cyprus is relevant for Europe s financial stability) 3. Inflation excluded by the ECB! So we have a problem: How will it be solved? Inflation is attractive for governments because they don t have to tell their citizens what the burden is the costs are hidden 26

28 The fiscalization of monetary policy the risk of higher inflation 27 The ECB has once again stepped in, and this may lead to inaction on the part of governments to do the necessary reforms And: The ECB is not independent anymore Central bank independence is crucial for a successful stabilization policy Not just old-fashioned Ordnungspolitik, but at the core of macroeconomic research You don t have to believe in the fiscal theory of the price level fiscal dominance may do Inflationary episodes of the past show that dependence on fiscal policy can create inflationary pressures

29 It cannot go on forever, so it will stop: Interaction of monetary and fiscal policies 28 The exit in the US would mean that interest rates for government bonds rise to 4 or 5 % just if they return to normal Given the fact that most debt is short term, this raises the deficit by $ 600 bill. or more: How will the US Congress respond? How long can investors be made believe that government debt is 100 % safe? This is what governments have told us and what Draghi emphasized If investors have doubts, there may be a run which may only be stopped by printing more money

30 What does all of this mean for the forecaster? 29 We usually assume that the crisis (or the crises) will not escalate or will somehow be controlled by economic policy But with the time moving on, we see more and more developments that look unsustainable from the macroeconomic perspective Since we cannot know when the situation gets out of control, we may be wrong with our baseline forecast All we can do is point out the risks to the forecast, and they are in my personal view extremely high today