Eurozone

Fed doves ready to act

June 17, 2012 4:09 pm by Gavyn Davies

As the eurozone crisis enters a critical phase, market attention is once more focused on the central banks to contain the crisis. They have promised in advance to provide unlimited liquidity to solvent financial institutions if necessary in coming weeks, which is now their standard response to financial shocks. However, the slowdown in global activity caused by the euro crisis may mean that they are thinking of acting more aggressively than that. A further large bout of unconventional easing is now on the agenda. Read more

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Posted in Central Banks, Eurozone, Global economy, Macroeconomics, Monetary policy |

The ECB should act before another crisis

May 3, 2012 4:30 pm by Gavyn Davies

Today’s governing council meeting at the ECB marked a return to “business as usual” after the dramatic injections of liquidity into the banking system in December and February. The ECB understandably wants to return to its regular duties, where it focuses on keeping inflation below its 2 per cent long term target, and is desperate to shift the burden for other aspects of managing the eurozone economy back to member governments.

Mario Draghi’s main message in recent weeks has been that “the ball is in the court of governments” in three different ways: the need for fiscal consolidation, bank recapitalisation and a “growth strategy” involving labour and product market reform. Assuming satisfactory progress on these three objectives, the ECB would retire to the relative obscurity of inflation control, a place where it is always happy to find itself. “Non standard” monetary measures, which involve the use of the ECB balance sheet to finance troubled banks and sovereigns, would no longer be needed.

Unfortunately, it is improbable that the ECB will be granted its wish to remain on the sidelines for very long. The key question is how, when and where it will be called back into action. Read more

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Posted in Eurozone, Macroeconomics |

Spain in the austerity trap

April 1, 2012 4:29 pm by Gavyn Davies
Spanish workers demonstrate in Madrid during a national strike, 29 March 2012. Image by Getty

Spanish workers demonstrate in Madrid during a national strike, 29 March 2012. Image by Getty

It was always likely that Spain would prove to be the key battleground in the eurozone crisis this year, and so it is proving. If the eurozone’s austerity strategy, based mainly on the imposition of fiscal contraction in the peripheral economies, works in Spain, then it will probably work elsewhere. But if it fails in Spain, the long term outlook for the eurozone would seem ominous.

The EFSF/ESM “firewall” announced last week was at the low end of market expectations, providing new funding for future crises of only €420bn by July 2013, and €500bn a year later.  A medium sized Spanish crisis, involving both the sovereign and the banking sector, would comfortably absorb most of that, leaving nothing over for the many other potential calls on the eurozone’s bail-out funds. That is why the market was so focused on the Spanish budget announcements on Friday. Read more

Posted in Eurozone, Macroeconomics |

ECB liquidity is not a free lunch

March 4, 2012 12:20 pm by Gavyn Davies

The initials LTRO, barely ever discussed prior to last December, now form the most revered acronym in the financial markets. Before the first of the ECB’s two Longer Term Refinancing Operations in December, global equity markets lived in fear of widespread bankruptcies in the eurozone financial sector. Since LTRO I was completed on December 21, equities have not only become far less volatile, but have also risen by 11 per cent.

With LTRO II completed last week, over €1tn of liquidity has been injected into the eurozone’s financial system. Private banks were permitted to bid for any amount of liquidity they wanted, the collateral required was defined in the most liberal possible way,  and the loans will not fall due for three years. Any bank that might need funds before 2015 should have participated to the hilt, thus eliminating bankruptcy risk fora long time time to come. Read more

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Posted in Banks, Central Banks, Eurozone, Macroeconomics |

A global experiment in the fiscal/monetary mix

February 19, 2012 2:25 pm by Gavyn Davies

A large and important change is underway in global economic policy. This change will determine whether the developed economies can grow their way out of recession. Although the new strategy has been tried before by individual economies, this is the first time it has been adopted on such a global scale. If it fails, it is far from clear that policy-makers have a ready-made alternative plan waiting in the wings. Read more

Posted in Eurozone, Global economy, Macroeconomics, Monetary policy, US |

Eurozone’s reluctant take-over bid for Greece

February 17, 2012 1:43 pm by Gavyn Davies

Talks in the eurozone about the intended €130bn bail-out package by the EU and IMF have become more convoluted than ever this week. The latest deadline for a final decision by the eurozone is now said to be Monday, and there is no certainty that the deal will be ratified even then.

However, assuming that the Germans, Dutch and Finns are willing to sanction the deal, which on balance seems likely, the package will produce a further large increase in the exposure of eurozone taxpayers to Greece, without reducing the overall burden of Greek indebtedness very much at all.

The deal would therefore involve a further big step towards the “socialisation” of Greek debt to other eurozone sovereigns, while reducing the exposure of the private sector to any further Greek default. From now on, the burden of Greek debt will either by borne by Greek taxpayers, or by eurozone/IMF taxpayers, depending on whether additional defaults occur in future. It will be a simple head-to-head between sovereign governments, which is why the debate is becoming so heated. Read more

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Posted in Eurozone, Macroeconomics |

How the Fed defeated President Truman to win its independence

January 20, 2012 2:36 pm by Gavyn Davies
Federal Reserve. Getty Images

Getty Images

In 1951, an epic struggle between a US president who stood on the verge of a nuclear war, and a central bank that was seeking to establish its right to set an independent monetary policy, resulted in an improbable victory for the central bank. President Harry Truman, at war in Korea, failed in a brutal attempt to force the Federal Reserve to maintain a 2.5 per cent limit on treasury yields, thus implicitly financing the war effort through monetisation. This victory over fiscal dominance is often seen as the moment when the modern, independent Fed came into existence.

The idea that the central bank should place a cap on the level of bond yields is firmly back on the agenda, at least in the eurozone. This week, Italian prime minister Mario Monti said that he was increasingly optimistic that his country’s bond yields might soon be capped. Although he stopped short of saying that this would be done by the European Central Bank, there really are no other viable candidates to achieve this. Furthermore, many economists are arguing that this is the right policy, since Italy is now following a sustainable budgetary policy which deserves to be rewarded by ECB action in the bond market. Read more

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Posted in Central Banks, Eurozone, Macroeconomics, Monetary policy |

US immune from eurozone contagion so far

January 4, 2012 5:47 pm by Gavyn Davies

In the second half of 2011, the US economy appeared to buck the impact of the eurozone crisis, with American economic data surprising on the strong side in the final quarter of the year. But, as the new year begins, it seems improbable that economic activity in the US and the eurozone can remain so divergent for much longer.

Will the weakness in the eurozone eventually bring the US economy to its knees? Or will the greater resilience of the US win the day? The answer to these questions will determine whether the global economy will experience a double-dip recession in 2012.

The data released over the holiday period seem to be pointing in a more optimistic direction than markets have recognised. A year of above-trend growth certainly looks like a stretch in the present environment of fiscal tightening and global deleveraging. But the risks of a global double-dip recession appear to be receding, at least for now. Read more

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Posted in Eurozone, Global economy, Macroeconomics, Recession, US |

ECB balance sheet sucked further into the crisis

December 21, 2011 7:43 pm by Gavyn Davies

The explosion in central bank balance sheets continues. As explained in this earlier blog, the ECB, the Fed and others have become the holders of last resort for much of the private sector risk which no-one else is willing to touch. Today’s announcement of a record liquidity injection by the ECB, along with a further rise in the Fed’s balance sheet as part of the dollar swap programme, looks particularly dramatic, but it really just represents a continuation of a process which has been underway for many months now.

Whatever they may claim to the contrary, the ECB is finding that it has no choice but to use the central bank balance sheet to stabilise the euro crisis. I am not complaining about that. The alternative would have been far, far worse. But we should call a spade a spade. This is quantitative easing on a significant scale, and the lines between this form of QE, and the direct monetisation of budget deficits, which is forbidden by the spirit of the eurozone treaties, are becoming increasingly blurred. Read more

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Posted in Eurozone, Macroeconomics |

Eurozone crisis might move from acute to chronic phase

December 9, 2011 1:12 pm by Gavyn Davies

Amid all the focus on the UK’s decision to use its veto, it is important not to miss the main economic outcome of the summit, which is that the agreement heralds a new era in European policymaking. The German approach to fiscal policy will now be writ large across the eurozone. This raises three key questions:

  1. How different will this prove to be in practice from the old status quo?
  2. Is it a good idea from an economic point of view?
  3. Does it allow the European Central Bank in future to play the same role in the eurozone as the Federal Reserve and the Bank of England have been playing in the US and the UK?

My initial take on the deal is that it will be sufficient to dampen the acute phase of the crisis, but that the absence of a clear long-term strategy for growth means that there could still be a long period of chronic problems ahead. Read more

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Posted in Eurozone, Germany, Macroeconomics, Monetary policy, UK |
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