Category: Economical policy

Introduction

The European League for Economic Cooperation-French section (ELEC-F) has organised a Citizens for Europe Consultation, approved by the ministry in charge of European Affairs, on the topic: “What improvements are desirable and realistic for the eurozone, from an economic and social point of view?”.
This Consultation took place in two stages.

• On 18 September, an initial meeting was held in order to pool the expectations, questions and proposals of the participants and to discuss them with three well-known economists: Agnès Benassy-Quere, Patrick Artus and Xavier Timbeau, as well as the President of ELEC-F, Olivier Klein. This debate was led by Emmanuel Cugny, editorial writer at France Info. Around 90 people participated.
• On 16 October, a second meeting was held to summarise the conclusions and recommendations of this Consultation.

The two meetings were held in the BRED auditorium, 18 quai de la Rapée, 75012 Paris.
 

Summary : findings, proposals:

1. FINDINGS

The single currency

In the wake of Robert Schuman’s statement of 9 May 1950, the euro is one (and not the least) of these “concrete achievements which first create a de facto solidarity” that punctuate the construction of Europe. The 12 Signatory States of the Maastricht Treaty (1992) which took the major decisions, declared themselves “[determined] to promote economic and social progress […] through the establishment of economic and monetary union, ultimately including a single currency in accordance with the provisions of this Treaty”. Under the name of the euro, adopted in 1995, this single currency came into force in two stages, on 1 January 1999 and 1 January 2002, and the eurozone  currently has 19 members. What is our view today on the usefulness of the euro and desirable improvements?

The single currency brings a basic economic benefit to its members by eliminating exchange fees between them. Above all, however, it eliminates exchange risk, facilitating the movement of capital and business within the zone. A second advantage is the sharp fall in interest rates brought about by the creation of the euro in many countries in the zone, be it through the effect of markets until 2010, or later through the action of the ECB. These lower rates facilitate business investment and reduce the burden of sovereign debt (government bonds in the financial market); without the euro, France’s public debt service, for example, would cost an additional €50 billion per year, or 2.5% of GDP. It should be noted, however, that the low interest rates experienced by some Southern countries prior to 2010 led to overindebtedness in the private sector.

It is also worth adding that, if the eurozone were a complete monetary zone as in the case of the United States for example, it would allow for differentiated growth rates within the same zone due to the coexistence of current account balances, some of which are in deficit and some of which are in surplus. In this kind of situation, countries with current account deficits would not be led to seek a lower growth rate than that corresponding to their needs (demographic needs for example). With an optimal organisation of the eurozone, the external constraint would only apply to the boundaries of the zone and not to the limits of each country forming it. From a consolidated point of view, the eurozone is currently one of the healthiest areas in the world in terms of its current account and public debt as well as enjoying a stable currency.

The usefulness of the euro has also been demonstrated in major recent upheavals the freezing of interbank loans after the collapse of Lehman Brothers and the recession caused by the severe financial crisis; the explosion of “spreads” on the public debts of Member States, the threat of deflation, etc. The single currency protected every country in the zone in 2008 and 2009; if each country had kept its own currency they would have certainly been weaker in the midst of the major financial crisis. The ECB has since been able to implement an extremely active, useful monetary policy. In addition, during the crisis specific to the eurozone, the institutional mechanism was expanded, in order to strengthen the resilience of the single currency, with the establishment of the Banking Union and the European Stability Mechanism.

As is demonstrated by the opinion polls in all member states, citizens currently see the benefits of the euro in a positive light, as the single currency not only facilitates travel but also more importantly offers protection. However, the advantages of the euro need to be highlighted and explained more effectively.

It would then be clearer to citizens that a complete eurozone could provide Europe with the capacity to act as a global player on the same levels as the United States with the dollar today and China with the yuan tomorrow. This renewed impetus at European level should also enable us to combat the effects of the extraterritoriality of American power. All in all, the citizens of each nation could therefore have more control over their own destiny.

Macroeconomic imbalances

“Convergence between European countries”, a major objective of successive treaties, was effective until the 2008 crisis, with the notable exception of the issue of current accounts. Since the crisis, however, it has been replaced by differences in living standards and a widening of macroeconomic imbalances  between the member states of the eurozone  Thus, after an initial period of convergence, the situation since the financial crisis specific to the euro zone is one of divergence between its Member States which is structural, cumbersome and multidimensional and which will inevitably take time to lessen.

One of the major difficulties is the lack of movement of capital between member states of the eurozone since 2010.  Northern countries accumulate huge current account surpluses (currently amassed outside the eurozone more than within the zone) , but deposit all these savings outside the eurozone.

In the United States the private sector accounts for two-thirds of financial stabilisation (cross-capital flows between different States) with the remaining third being provided by the federal budget. The eurozone currently has neither.

This situation also reflects a geographical polarisation of production, which is concentrated in the northern countries and snowballs. Wage costs per unit produced have varied for a dozen or so years in a non-cooperative manner. Adjustments have therefore only affected southern countries in the form of “internal wage devaluations” and lower investment expenditure. These internal devaluations also have the collateral consequence of increasing actual debt (which is not devalued in parallel) and have had extremely problematic social and political repercussions. Salary re-evaluations in the northern countries are as yet in their infancy. Labour mobility is beneficial for northern countries but detrimental to those in the south. The divergent process is therefore cumulative.

Budgetary stability rules cannot be the only regulatory instruments applied in the monetary zone. In all events, they most certainly need to be simplified and revised. Structural convergence tools (structural funds) are abundant, poorly coordinated, ineffective and highly concentrated in non-eurozone countries. The European Stability Mechanism established in 2012 is an important non-monetary instrument in terms of guaranteeing financial support if a member state encounters an asymmetric shock. However, its working methods are felt to be too intrusive by beneficiary states and the European Parliament and are difficult to implement due to the established unanimity rule.

Overall these socio-economic divergences contribute to the mistrust of public opinion and the rise of sovereign populism.
Europe must find the path towards upwards convergence. It needs to rediscover the real reasons behind this community of interest. Subsidiarity must not get in the way of interdependencies between member states, which fully justify interactive cooperation.

Northern countries have a long-term interest in maintaining solidarity with those in the south as, if producers were to continue to move significantly closer to purchasers, a large dynamic, sustainable European internal market would be a major asset and preferable to commercialism. In addition, and above all, a possible break-up of the eurozone would certainly have dramatic consequences for countries in difficulty but would lead to a major revaluation of the currencies of northern countries, which would considerably weaken their own economy.
 

2. OUR PROPOSALS

In our view, it is absolutely essential to maintain and consolidate the euro by completing the organisation of the eurozone:

1. The fundamental role of the ECB must be maintained as a lender of last resort in the event of systemic shocks in order to preserve the euro whatever it takes, while ensuring its stability.
2. Citizens of the European Union need to be aware that the European currency represents power and autonomy at world level against the US dollar and against the Chinese yuan in the future. The development of the role of the euro as an international currency against the dollar is to be recommended in order to move away as far as possible from the extraterritoriality of the laws of the United States.
3. The Banking Union needs to be consolidated: the aim is to finalise the resolution mechanism by implementing a safety net for public funds and introducing a common guarantee for bank deposits alongside the acceleration of provisioning of defaulting loans (classified NPLs) on the banks’ balance sheet.
4. We need to develop an IMF-type institution (based on the European Stability Mechanism), which can help countries in asymmetric balance of payments crises, without the creation of money.
5. In addition to this balance of payments risk management instrument, we need an actual cyclical stabilisation fund or a specific eurozone budget with a counter-cyclical and/or risk-sharing focus. This budget, which would be financed by own resources, would have to be put to the vote of a democratic institution, such as one stemming from the European Parliament. Further risk-sharing mechanisms may be possible within the eurozone which can take different forms (partially pooled unemployment insurance system, pooling of a proportion of public debt, etc.).
6. These risk-sharing systems must be conditional on the responsibility exercised by each country (structural reforms, budgetary situation, etc.). It is pointless to appeal for solidarity without responsibility. It should be pointed out, however, that whilst moral hazards must not be ignored, neither must they inhibit solidarity. A balance between these two principles needs to be obtained.
7. The return of capital mobility between eurozone countries is absolutely key so that the current account surpluses in certain countries can finance the deficits of others and encourage a healthy allocation of capital within the eurozone. The proposals outlined above should make a significant difference in this respect as they would restore the confidence of the financial markets in the unity and cohesion of the zone. We therefore need to pursue the course laid out by the Juncker Plan. The Capital Markets Union (CMU) should also be prioritised.
8. Surplus savings should be used to finance projects for the future (ecological transition, biotechnology, digital etc.) as well as to finance investment projects of this kind in southern countries. These could include public-private projects. This would also provide greater visibility and a better understanding of the usefulness of Europe.
9. In order to reduce the cumulative geographical polarisation of production systems and to encourage a cooperative development trend in all the member states of the eurozone, there is a need for a system which creates a productive rebalancing vision for the different areas within the eurozone to support the above-mentioned points and to rethink the instruments used (structural funds, incentives and private investment guarantees).
10. The current mechanism for monitoring macroeconomic divergences needs to be adapted particularly in terms of stepping up the monitoring of imbalances in current accounts and wage costs per unit produced. Greater emphasis needs to be placed on dialogue between social partners at eurozone level, in particular to avoid a social downward spiral.

3. CONCLUSION

It is important to highlight the benefits of the euro and the ways in which it protects citizens.  It is also vital to stress that the single currency strengthens the bond within the zone and creates de facto solidarity. It is a means of promoting peace. The destruction of the euro would have severe consequences for Europe.

We therefore believe that it is necessary to promote an educational campaign, notably in the form of a dictionary of received ideas, in order to combat inaccurate or even malicious rumours which abound concerning the history and outcome of European construction.

You can find the original summary here.

The commission has adopted a number of recommendations on this major topic, for more convergence and a better adhesion of people to the European Union, as well as more sustained and more inclusive growth in Europe.
I participated in the debate as well as the recommendations as President of the French Section of the European League of Economic Cooperation.

 Some forgotten findings:

• After a period of clear rapprochement during the first period, from 2000 to 2007 (spreads brought down to almost zero, economic catching up of peripheral countries), diverging trends which were already manifest in term of current account and public budget deficit have become very serious since the crisis of 2008 and 2011 took place; they seem to be on the down side once again, but much too slowly.· Living standards discrepancies within the EU have declined (from 1 to 3 twenty years ago to 1 to 2 nowadays); but they remain important between Northern and Southern or between Western and Eastern Europe. Furthermore, they have in most cases increased within each country.
• The single currency (euro) has undeniably played a big role in knitting the eurozone economies more closely together; however the unfinished unification of capital market remains an obstacle on the way. Additionally, it appears that the contribution of structural funds towards more converging economies has been even more significant than that of the single currency.

Our proposals:

• Set convergence as the centrepiece of EU recommendations and actions, by monitoring investment, unemployment and living standards indicators on an annual basis.
• Reduce the asymmetry between balance of payments indicators and policies.
• Pursue the capital market integration as quickly as possible and complete the European Banking Union (notably the bankruptcy resolutions mechanism and deposit guarantees scheme).
• Make additional own resources available at EU level, so as to push up the Multiannual Financial Framework to 1.5 % of GDP in order to invest into innovation, digital activities, cross boarder links and productive and competitive activities.
• Enforce solidarity between member States by setting up investment guarantee scheme, moving towards better tax harmonization and reacting jointly against attempts to impose extraterritorial sanctions on EU banks and companies.

I. The Commission points out the following findings:

1. ​The economic convergence of the member countries of the European Union – and, within the eurozone, that of the euro area countries – has made significant progress until the 2008-2009 crisis: a sharp reduction in interest rate spreads and inflation; higher growth rates in catching-up countries; widespread reduction in public deficits and public debt. However, the situation was not the same for balances of payments and for public accounts in a few countries, leading to dangerous vulnerabilities.
   These vulnerabilities have become evident with the economic and financial crisis of 2008-2009, followed by the sovereign debt crisis of 2011-2012, which led to the return of very strong divergence and an explosion of debt and unemployment in many countries. However, a clear reduction in these differences has begun since 2014, thanks to the efforts of all governments and with the support of the EU.
2. Despite these upward and downward trends, the reduction of differences in living standards between the countries that currently make up the European Union has been considerable thanks to the rapid catching up of Southern countries, and, still more rapidly, Eastern European countries, whose degree of openness to foreign trade has increased considerably: the disparities between the per capita income of the EU’s poorest country and the average per capita income of the EU have been reduced from 1 to 3 in 1990 to 1 to 2 currently.
   However, in the eurozone, differences in living standards have increased again from 2010 onwards between the countries in the North and those in the South and they hardly stabilize.
3. ​Since its creation in 1999, the single currency has undeniably been a factor in bringing euro area countries closer together, facilitating and streamlining trade between them and bringing their economic policies closer together. The Stability and Growth Pact and the agreements that have completed it (“six pack,” “two pack,” etc.) have led to better coordination of budgetary policies. On the other hand, current balance-of-payment situations have remained very divergent while the convergence of social policies has only been very limited, which runs the risk of pushing the Union down the road.
   The unification of capital markets has also remained very incomplete; it is insufficient to compensate for the natural trend towards the concentration of productive forces in centrally located countries and which benefit from a long industrial tradition and efficient educational and training systems.
   Besides, the effect of the Structural Funds (ERDF, ESF) and the Cohesion Fund, which has contributed in some countries up to 3% of their GDP, seems to have been even more important to facilitate the economic recovery of the countries of Central and Eastern Europe as well as their modernization, with an increase of their per capita income. 
4. Whereas if the disparities between European countries have been reduced, income inequality per head within our countries remains important; they have even grown^[1], albeit far less than in the United States. In particular, the progress made in the peripheral countries of the European Union has been accompanied by a strong increase in inequalities within each country. Appearingly only part of the population in these regions benefited from the process of growth and convergence, while the rest of the population remained in great difficulty. 
5. All in all, social inequalities remained strong. The introduction of social indicators (unemployment rate, rate of activity, long-term unemployment, youth unemployment, productivity and nominal wages) in the “process on macro-economic imbalances'” (European Scoreboard) should, however, allow further progress to be made in the future.
   The initiatives of the Commission to give the European Union a “social triple A rating”, the development of a “European social rights Pilar” and its adoption at the European Social Summit for Fair Jobs and Growth in Gothenburg (November 17^th 2017) will considerably increase the attention given to safeguarding the “European social model” and help deter the race towards the lowest social level. However, Social Europe remains a work in progress, and projects such as a common European unemployment insurance scheme are still in limbo.

II. Willing to contribute to the development of policies so that Europe can cope with this multifaceted challenge, our Commission formulates the following recommendations: 

1. Convergence – specifically addressed by Article 3 of the Treaty of the European Union must be placed more at the center of the recommendations and actions of the European Union. The Scoreboard indicators should be more detailed, on an annual bases and not only on average triennial; their access should be facilitated and their distribution systematized and expanded.
   In particular, close monitoring must be insured, beyond the criteria for budget, indebtedness and structural reforms, on issues of growth, innovation and investment, unemployment, in assessing the policies of Member States and at the level of each region. A precise analysis of changes in income per capita disparities and standard of living between countries and within them should be made annually and accompanied by incentivizing measures. Similarly, the Union budget and, if necessary, the euro area budget should contribute to all these priorities. 
2. Monitoring the balance of payments must receive more attention and the criteria must no longer be unbalanced. It is inappropriate, in particular, for unbalances in balance of payments considered acceptable to be higher when it comes to surpluses than those retained when it comes to deficit (6% of GDP against – 3%, recently modified into a figure of – 4%). That is to forget the common sense observation that surpluses of countries are the deficits of others, at least worldwide. Reducing the asymmetry of adjustment policies between eurozone countries requires a better combination between the need for the fight against moral hazard and the required risk sharing.
   Some observe, however, that these figures are not significant enough and that capital flows must also be taken into account; the main progress would therefore be to move towards more integrated capital markets, in order to encourage investment in the European countries in need from overabundant saving countries. The “Brexit” is another reason to push this integration into the capital markets.
   All in all, in order to ensure  a sustainable co-existence of balance of payment deficits in some euro area countries and surplus in other countries,  these imbalances must, on the one hand, be maintained in reasonable proportions and dynamics and, on the other hand, the intra-zone capital market must become once again fluid, as it was before the eurozone crisis, so that the financing capacity of certain nations can cover the need for financing of others, particularly in the form of direct investment. This integration of the financial markets will only be recovered if each country conducts a sustainable policy and if intra-zone solidarity is affirmed, commensurate with the sustainability efforts of the economic policies of each individual.
   We also recommend that the current payments indicator of each EU Member State be detailed by providing  its balance of payments with the euro area as a whole and, more specifically, with each of the other euro area Member States in particular. It is also important to monitor very closely developments in productivity, annual salaries and the sharing of added value within each EU Member State. 
3.  At the same time, the European Banking Union must be completed with the setup of the deposit guarantee insurance scheme, as well as with the common ‘final backstop’ on public funds provided by the European Commission, so as to prevent a widespread contagion effect triggered by community resources, in the event of insufficient safety net at lower levels (guarantee of deposits and resolution mechanisms). Besides, work must continue for further development of the Capital Market Union. 
4.  The Multiannual Financial Framework (MFF) for 2021-2027, which has just been presented by the European Commission, provides – alongside entirely justified new expenditures on European security and defense, control of migration and support for reforms and investments – a significant reduction (5 %) in allocations altogether to the common agricultural policy and cohesion policy. This reduction could damage the necessary convergence efforts between our economies, although there is leeway to make these policies more efficient through more retributive schemes. This situation is aggravated by the heavy budgetary consequences of the British withdrawal.
   It is only possible to come out of this situation “on top”, i.e. by increasing the amount of this forecast budget. The amounts currently proposed for the MFF 2021-2027 represent 1,135 billion commitment appropriations (at 2018 prices), representing 1.11 per cent of the gross national income of the member countries. This percentage, even though it is slightly higher than the current MFF 2014-2020 (1.00%), must be improved, by further developing common resources, as announced in the MFF 2021-2027 (ecologic fees for instance). A ratio of 1.5% of national income would be a minimum for community action to have real impact. A revision of sources of income in EU budget could also be considered. 
5. Part of this essential budgetary effort should take the form of investment guarantees to encourage the private sector to engage in the construction and renovation of infrastructure, as well as other projects in energy, digital (broadband Internet), cross-border connections and productive and competitive activities, particularly in the least developed countries, in order to facilitate their catching up.
   This would be a logical extension and an amplification of the ‘Juncker Plan’ Investment, the effects of which were positive but too limited, especially given the fact that the most advanced countries in the EU have absorbed the majority of it. Funding could be partially provided in the form of project bonds issued by project companies; these bonds would benefit in whole or in part from the above guarantees.
6. Convergence, in other words the gradual rapprochement of our societies, requires a long-term vision. A specialized entity should be established with the Commission and the European Council to draw the medium-term perspective and follow it concretely year by year; an alternative course of action would be to entrust this function to an existing entity or a network of recognized institutes. 
7. Greater economic, social and territorial convergence, being the fundamental objective of the EU, also requires the implementation of our previous recommendations; particularly in the area of tax harmonization^[2] (June 5^th 2015), to ensure transparency and to avoid fiscal dumping or the social lowest bidder; or in relation to “the future of international trade, investments and trade negotiations” (June 17^th 2016), in order to avoid distortions of competition triggered by social inequalities and to combat tax havens and more broadly tax evasion. These need to be completed by the necessary measures to combat attempts to impose external monetary sovereignty and/or extraterritorial sanctions.

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[1] Measures from Gini Coefficient
[2] It means a reduction of differences – but not a unification – of public tax bases.

Bulletin Quotidien – 16/04/2018

Carbonnier, Lamaze, Rasle & Associé (known as Carlara) recently organised a lecture on leaving the ECB’s accommodative monetary policy behind, and the issues and challenges associated with doing so, inviting two speakers in the persons of Olivier Klein, CEO of BRED Banque Populaire, and Mathilde Lemoine, chief economist of Edmond de Rothschild Group and former member of France’s fiscal oversight body, the High Council of Public Finances.
Introducing the debate, Edouard de Lamaze, senior partner at Carlara, reminded the meeting of the circumstances under which the policy emerged, after the most severe financial crisis of the post-war era exploded in 2008. Next came a major liquidity crisis, bankruptcy after bankruptcy, a stock market collapse, a halt to investment and an economic recession that spread all round the world. The spectre of the 1929 crisis loomed, but subsequent events took a different path when, in 2009, economic activity recovered, thanks in particular to economic and monetary policy. Consequently, the Federal Reserve in the USA slashed its intervention rate and started to buy public stocks, which increased the money supply above spontaneous demand. Europe was also to recover in 2009 and 2010. But it rapidly hit a second financial crisis, within the eurozone, with the Greek crisis in particular and threats of similar scenes in Italy and Spain. The euro, on the verge of disintegration, came to be rescued by Mario Draghi, president of the European Central Bank since November 2011, when during a now-famous speech in London on 26 July 2012, he said the ECB would do “whatever it takes” to avoid the collapse of the eurozone (rates reduced to zero, or even negative, share purchase with no announced limits), thereby thus halting the most acute phase of the crisis in its tracks.

So, where are we now? Everyone agrees that we cannot remain in this situation where interest rates and monetary quantities are largely administrated. Furthermore, there are some signs implying that expansion is coming to an end, particularly in the United States. The question is also not only for financial markets, as some economic tension is being observed. Under such circumstances, how can withdrawing from such an unusual monetary policy be managed and at what pace should it happen? Will the ECB be able to control such an exit, or might it be taken by surprise? What should be done if growth falls again? Lastly, is this the end of divergence between eurozone countries or is divergence hidden by liquidity inflows? These are just some of the issues that Mathilda Lemoine and Olivier Klein will address. While they share the belief that the ECB needs to exit from the accommodative policy, they each have their own view of several of these issues. Thus concluded de Lamaze’s introduction.

Olivier Klein: The ins and outs of the European Central Bank’s non-standard monetary policy

Organised into five points, Klein’s talk, after an introduction to the current situation with the return of growth, and the mechanisms that brought about this success, highlighted firstly the factors that made these monetary policies essential, and then the factors that now make it necessary to leave these policies behind, provided that this only happens slowly.

The return to growth

One observation, first of all: Olivier Klein immediately stated that this is a successful monetary policy.

In fact, in 2017, the eurozone experienced 2.40% economic growth. Growth has been recorded for 19 quarters running, and moreover continues to strengthen, as in the fourth quarter the rolling annual growth figure was 2.70%. The purchasing managers index (PMI), highly correlated with growth, stands at a 12-year high, and is above its long-term average value. Another indicator, produced by Eurostat, the economic sentiment indicator, is meanwhile at its highest level for 17 years. Just some factors testifying to the eurozone’s return to growth.

The unemployment rate, meanwhile, has admittedly remained very significant but nonetheless distinctly down at 8.70%. The job losses sustained during the crisis were offset by net job creations appearing in 2013. This year, we have caught up with all the jobs lost in the eurozone as a result of the crisis. And unemployment has reached its lowest level for nine years.

In addition, since the announcement of the ECB’s measures in June 2014, bank lending rates for businesses have fallen by 120 basis points, while household rates have fallen by 110 basis points, reflecting the potent impact of monetary policies. This made a significant contribution to generating lending to non-financial companies, the trend for which saw an upturn late in 2014.

The non-standard monetary policy, begun in 2012 and followed whole-heartedly from 2014, has accordingly undeniably had a positive influence on the economic situation, Klein said.
Minor downside, the inflation rate stayed under 1% for more than three years, and even flirted with negative rates in the eurozone. Towards the end of 2016, it however began to climb slightly to stand at 1.3% in January. The ECB still views it as too low.

Consequently, as in the United States, despite economic recovery, inflation remains low. A source of some concern for the ECB, the risk of deflation does nonetheless seem remote. However, the ECB’s objective, to hit a rate closer to 2%, is yet to be achieved.

The mechanisms bringing about this success

To summarise the non-standard monetary policy measures taken by the ECB to remedy the situation:

• Interest rate policy measures, some non-standard, on two benchmark rates in particular, namely the refinancing rate and the deposit facility rate. In June 2014, the refinancing rate was cut to 0.15%, an historically extremely low figure. The deposit facility rate, meanwhile, was set at a negative value. Klein pointed out in passing that economists had for a long time viewed such a rate as impossible.
  In September 2014 and again in December 2015, these rates were lowered, reaching in March 2016 a central monetary policy rate of 0% and a negative rate on bank deposits with the central bank of minus 0.4%.
• Balance sheet policy measures: in June 2014, the ECB decided to grant long-term loans (4 years) to banks under very favourable terms, whereas the ECB usually followed a short-term refinancing policy; in September 2014 it decided to buy secure bonds and asset-backed securities, thereby beginning to buy private securities, an unusual policy on the Bank’s part; in January 2015, it announced the purchase of sovereign and quasi-sovereign debt in the eurozone; in December 2015, it recalibrated its purchasing policy by extending the duration of these purchases and announced that on maturity, the ECB would again buy so as not to let its holdings fall; in March 2016, it granted a fresh series of fixed-rate loans to banks on condition those banks relaxed their lending conditions to businesses; at the same time, it began to buy bonds issued by private firms with good credit ratings, thereby broadening the range of papers purchased under its balance sheet policy to provide favourable liquidity conditions and lower rates; a further recalibration with regard to buying sovereign or quasi-sovereign debt was undertaken and the ECB increased its purchases from €60bn to €80bn in April 2016; in April 2017 it reverted to €60 billion; in October 2017 the ECB announced a change to its accommodative policy, with a decrease in the monthly rate from €60 billion to €30 billion of net asset purchases commencing January 2018, these asset purchases being due to continue “until the end of September 2018, or beyond, if necessary, and in any case until the Governing Council sees a sustained adjustment in the path of inflation consistent with its inflation aim”, as the Bank said at the time. The ECB further announced that it will reinvest “the principal payments from maturing securities purchased under the asset purchase programme for an extended period of time after the end of its net asset purchases, and in any case for as long as necessary”. On 8 March 2018, the ECB, which was continuing the process of withdrawing from quantitative easing, removed the reference to the possibility of increasing the volume of debt purchases in the event of an economic crisis from its strategic communications. The pace of debt purchases was therefore capped at €30 billion per month, with a complete halt provisionally scheduled for September 2018 (see Bulletin Quotidien newspaper on 9 March 2018).

While the ECB initially seemed to be facing a problem of transmitting monetary policy to financing the real economy, the divorce between the two ultimately did not take place, said Pascal Poupelle, Chairman and CEO of Isos Finance. Consequently, France saw only one year when banks reduced lending to business. Poupelle wondered how this could be explained. Part of the answer lies in the general good health of French banks, Klein said, unlike banks in Spain, Italy and Portugal, and to a lesser extent Germany. For banks to be able to grant loans, they still need not to have too large a shortfall in their provision for bad debts, otherwise they will need to housekeep their balance sheet before attempting to drive forward. This is the transmission belt for monetary policy. However, this does assume that economic actors are not carrying too much debt, Klein reiterated.

Mathilde Lemoine, meanwhile, added that when the ECB saw it was not managing to reduce rate variances, it began its programme of buying sovereign debt. This is determined by a basis for allocation that is a function of the share of each country in the Bank’s capital. In actual fact, it could go a great deal further, as it did during the French presidential campaign. It acted similarly in Portugal, thus taking liberties with rules hitherto judged intangible. This enabled it to reduce rate variance and smooth out the risk premium. In addition, fundamentally for the future of the eurozone, Mario Draghi hinted that if a real crisis arose in a country, he would move beyond the usually accepted basis for allocation, and do so long term. This is when we saw the variance in rates between Portuguese and German lending reduced significantly. Therefore there is firstly classic transmission of monetary policy and secondly the liberties taken by Eurosystem and Draghi, consequently giving investors the signal that speculation served no purpose.

Why were these monetary policies essential?

The use of such non-standard measures proved essential insofar as traditional policy instruments had shown their limits in terms of both boosting growth and bringing down long-term rates for both governments and companies.

It was then a dual challenge to be tackled. In fact, besides the severe crisis into which the eurozone was plunged and the deflationary risk which was emerging, another risk surfaced in 2010, namely the disintegration of the eurozone, partly owing to how it is organised and a very marked balance of payments crisis in the eurozone’s southern countries. To prevent its disintegration, it was vital for the ECB to break the vicious circle that had become established firstly between banks and nation states, and secondly between interest rates and government debt. The market, fearing insolvency would hit certain countries, caused rates to rise in order to increase the risk premium, thus triggering a snowball effect, as countries took on debt at a much higher cost, thereby further making their solvency even worse. Only an economic actor outside the actual market could act to calm the market under such circumstances.

It has been the ECB and the famous “whatever it takes” statement by its president Mario Draghi, that through the various measures described and quantitative easing, prevented the disintegration of the eurozone and calmed down markets, and then remedied the situation when, as Klein said, American banks had stopped lending to European banks and European banks had stopped lending to each other.

But the credit squeeze was still to be tackled to prevent a solvency crisis affecting both governments and private economic actors. For that, long-term rates had to be brought down. This is what the ECB managed by applying the non-standard policy measures mentioned above. Negative short-term rates undeniably encouraged banks to grant more loans, preferring to lend at 1.50% rather than place their own surpluses with the ECB at a negative rate of -0.40%, giving a favourable impact on long-term rates thanks to quantitative easing and forward guidance on interest rates in order to maintain low rates over the long term, with the Bank committed to pursuing an accommodative policy for as long as necessary.

Accordingly, in late 2014 and early 2015, inflation rose slightly and, importantly, so did lending, as private-sector bond yields declined. Confidence was gradually returning and the lower cost of debt, boosted by a wealth effect, resulted in the appetite for borrowing returning, both for ongoing spending and for investment plans. So the economy was gradually restarting.

Another important factor, Olivier Klein reminded the audience, was the depreciation of the euro. When the ECB undertook this policy of balance sheet volume, it brought long-term rates down and the euro depreciated, by 16% compared with 2015, before stabilising in mid-2017. For the French economy and southern countries, it was something of a favourable change which, moreover, helped inflation to fall less.

The factors making it necessary to halt the accommodative policy

The accommodative monetary policy was an undoubted success. Nonetheless, it must be halted. In fact, movement started late in 2017, will continue in 2018, even early 2019.

There are various reasons for this: while interest rates are lower than nominal growth rates, this facilitates debt reduction. On the other hand, it is just as easy to take on new debt. The risk is that, as in the past, the speculative bubbles of euphoric phases will develop. However, Klein warned, we have clearly been in an area of uncertainty since 2017. Evidence of this is seen in risk premiums at their lowest level in fifteen years, resulting in under-valuation of risk, less selective credit offering, loans with less protection, and loan applications that are sometimes reckless, and sharply increasing. Similarly, it is seen that institutional investors are taking more risks in their search for a better yield than that provided by lending at negative interest. This under-estimation of risk is not too serious at this stage, but cannot last without posing a problem in terms of solvency.

Besides the potential effects on property, continuing with such a policy could have an impact on soaring share prices. Less in the eurozone than in the United States. And that is in fact what has happened. For all that, Klein believes, it would do no harm if the warning came sooner rather than later because in two or three years, the bubble would be even larger and the effects when it bursts would be much more serious. The correction that occurred in February was salutary, he added. It would be desirable for the market not to recover too quickly.

For these different reasons, announcing and then starting to halt this policy was becoming a matter of urgency. Especially as the negative interest rate policy, while it undeniably had a beneficial effect on the level of credit granted, and therefore on the economy, was nonetheless significantly eroding bank margins. Consequently, taken in the aggregate, French banks’ net interest margins (loan interest minus interest on deposits) had dropped, including overall net banking income, for the last two and a half years, Klein said. It was not a problem if it remained sporadic. It would become a problem if banks net earnings continued a downwards trend, thereby affecting their solvency ratios.

Aware of this risk, in October 2017 the ECB announced it was scaling back its accommodative policy (see above).

In this regard, Charles de Boisriou, a partner at Mazars, asked the two speakers about the consequences that a return to more standard policies might have on the activities of their respective companies, given the specific features of each.

Olivier Klein said that BRED, as a commercial bank, would like to see the situation get back to normal and revert, gradually, to a policy where rates were no longer negative, and without quantitative easing (QE) which pushed long-term interest rates downwards. A lessening in QE and a gradual return to slightly more normal long-term rates would be good for a commercial bank. It means the bank can again generate profitability enabling it to continue lending growth. Banks have to cope with a contradiction between banks’ regulatory policies on the one hand, which set solvency ratios that have to be met, and increased requests for loans from economic actors on the other. This, in return, demands a strengthening of banks’ equity. However, rates must not rise too quickly, and especially not short-term rates. In this respect, the ECB’s intention to firstly put an end to quantitative easing and then secondly to raise its key rates, i.e. short-term rates, is rather a good thing, Klein believes.

In the event, the most likely at this stage, that a rise in rates will be the result of a rise in expectations of nominal growth, this will naturally have a positive impact because it will mean that the macro-economic outlook for profitability will finally match the financial market’s hopes, Mathilde Lemoine added. However, a real gap can be seen between the financial market’s hope that is supported by central banks, and the macro-economic reality, often actually more disappointing than the markets imply, she noted. The question is to determine at what point the two will meet. Will the markets converge towards the weak potential growth of the economy, or will the opposite happen? If economic growth accelerates faster than anticipated, then the banking sector will need to manage risk taking. If, like Edmond de Rothschild Group, you have a tradition of investing in real assets, then you look at the fundamentals, she continued. However, these are less attractive than the sharp rise in financial markets would imply. The real difficulty therefore arises from the disconnect between monetary policy which gives some time, and the weakness of potential growth. Ultimately, governments tend to wait as long as possible before starting reforms, hoping that economic growth will start and support asset prices. But experience shows that it never happens like that. The adjustment variable is productivity.

Why it will only happen slowly

Olivier Klein said the situation is a paradox. Anticipation of rising rates is growing, the euro is climbing back up, resulting in deflationary pressure, which as a result could hamper the ECB in its wish to discontinue the policy while, it should be reiterated, the ECB’s objective is to see inflation rise to a level of roughly 2%. This phenomenon is one of the reasons why the ECB does not intend to move too quickly.

The second reason is, in the eurozone, high levels of debt in both governments and private borrowers (business and households alike). As regards companies, the ratio of loans to GDP in the United States is 73%, and in the eurozone it is 103%, Klein stressed. The level of private debt for business ± households in France is, meanwhile, up to 192% of GDP. Under such circumstances, putting rates up too quickly could render many businesses and individuals insolvent.

Third reason: as the ECB considers it essential for eurozone countries to put more wide ranging structural reforms in place so as to restore potential growth and limit public deficits and debt levels, it intends to give them a little time, thanks in particular to the flexibility provided by these low rates.

Lastly, if rates are increased too quickly, the repercussions on markets could well be negative. While the ECB wants to avoid creating bubbles, it does not want to drag markets downwards either. This would result in a negative wealth effect, which is the wrong signal for the economic environment.

On the back of this analysis, Olivier Klein anticipates a probable rise in short-term rates in 2019, preceded by the end of quantitative easing, i.e. zero purchases by the ECB. The Bank will however gradually allow the bond assets it acquired to be repaid.

It will be 2019 because the aggregate negative output gap, which was created during the crisis between the potential growth rate and effective growth rate, will be closed, according to the apparent consensus. For now, growth in 2017 in the eurozone stood at 2.40% (see above) whereas potential growth is evaluated at about 1.50%. However, it will not be possible to remain significantly above that, Klein believes. It will also coincide with the end of Draghi’s term of office in November 2019. If, as is reckoned likely, a German successor or one close to German ideas in this regard were appointed, the ECB could be driven to return to a more traditional monetary policy more quickly. These various factors argue in favour of a rise in rates. Not to overlook the United States where rates are also likely to climb, and more quickly. Europe could possible see a contagion effect, Klein concluded.

Joining the discussion, Michel Didier, President of COE-Rexecode, believes that while there is admittedly a risk in moving too fast, there would also be a risk in moving too slowly. He sees four questions arising:

• Moving too slowly would facilitate excess and the risk is that bubbles would appear;
• The ECB does not sufficiently relax pressure on governments to return to sustainable budget positions. It would, moreover, delay eurozone convergence at a time when we are tending to see competitive divergence;
• The ECB does not get into position quickly enough to respond if the economy starts to decline again;
• Lastly, it would facilitate the extension of growth in Europe, above its potential. It would thus intensify the tensions that are appearing in the real economy: recruitment difficulties, very low unemployment in Germany causing pressure on wages; lengthening delivery lead times. These tensions have not yet brought about inflation because inflation is a fairly inert variable. But not much inflation is needed to cause imbalances on bond markets, Didier remarked.

Mathilde Lemoine: a critical macro-economic analysis of the European Central Bank’s monetary policy

Addressing the issue with a more macro-economic approach, Mathilde Lemoine reiterated, by way of introduction, that there was no historical precedent for the completely original monetary policy followed by the European Central Bank. She added that in addition, there is no theoretical monetary analysis available to understand the consequences. In 2009, the G20 gave central banks a mandate to also oversee financial stability, in so doing making it one of their top objectives. However, this created an obvious conflict of interests between this search for financial stability and running monetary policy, which implied that the central bank always had to lag behind the economy, hence the appearance of bubbles.

Objectives

Before anything else, Lemoine underlined, it was important to properly understand the objective the ECB planned to pursue to support investment, growth, and ultimately inflation which remains, of course, the first policy goal. The aim is to change the behaviour of economic actors, primarily in their saver role, to encourage them to save less and spend more. But the ECB also plans to intervene in redistribution, Lemoine said. By setting rates very low, or even negative rates, the central bank wants to encourage these economic actors to change their behaviour, and to take more risks to support investment. But taking more risks entails the risk of losing capital. A form of redistribution operates, from those with assets to younger people. There could be a political danger in seeing the ECB follow a policy of redistribution on the grounds the young have suffered more from the crisis, in Lemoine’s opinion. Consequently, and logically, will the ECB continue to apply a policy of very low rates, its objective, which should always be kept in view, remaining that savers receive no remuneration for saving.

Klein differed here from Lemoine, believing the redistribution effects resulting from monetary policy are not caused by quantitative easing alone, but the entire monetary policy. Whenever real interest rates are higher than growth, savers are the winners and borrowers are the losers. Whenever monetary policy is designed to support the economy, and real interest rates drop below growth, then in contrast borrowers are the winners and savers are the losers. Which is not serious if it is only temporary. It would be a different matter if it were a long-term situation, he believes.

The President of the ECB moreover requested banks to housekeep their balance sheets and remove bad debts to enable them to offer lending rates to businesses and households that were lower and more consistent with the benchmark rates set by the ECB itself, without reducing the margin excessively by doing so, Lemoine continued. While banks, at the time negative rates were instituted, emphasised how much such a policy would hurt their margins, Draghi reckoned they could easily take the hit, as asset prices had increased. The ECB thus enabled lending to recommence, a return to growth, and a slight rise in inflation.

The European Central Bank’s second objective is to reduce the real rate at a time the Bank feared it was facing a liquidity trap. In fact, if real rates are zero and inflation is decelerating, close to a deflation situation, the real rate, i.e. the nominal rate minus inflation, increases. The lower inflation is, the more the real rate climbs. The ECB therefore wanted to decrease the real rate by acting on inflation.

In this regard, note that the refinancing rate, which determines all lending rates to households and businesses was, taking inflation into account, -0.35% in June 2014. In contrast to what is conveyed about the increase in this rate, the real refinancing rate is now -1.3%, distinctly more negative than at the time, because the ECB has managed to push inflation up. The real rate is therefore substantially more negative. The Bank has thus fulfilled its mandate and escaped the liquidity trap.

It has met another objective, specific to the eurozone, which is the reduction of variance in rates between different countries within it. In fact, the ECB needs to resolve two issues here. First, it must allow a fall in rates for the whole eurozone; and second, it must ensure that the 10-year borrowing rates – the benchmark rates for Germany – are not too far removed from those of Spain or Italy, which it managed to do, as the gap between lending rates in Italy and Germany was slashed from 420 basis points to 130 basis points between 2014 and 2018. The gap for Spain was cut to one sixth of its previous size. Portugal saw comparable changes, its rate now being even lower than the rate in Italy.

Lending recommences… but more than 80% concentrated in France and Germany

The ECB has admittedly met its objectives and this is indeed reflected in increased lending by banks. However, Lemoine said that this upward trend seen since late 2016 has, in terms of lending to businesses, been highly concentrated on two countries taking 80%, i.e. France (51.2%) and Germany (32.4%). An identical trend is seen for lending to households, with 87% of the rising in property loans also being in these two countries. Under such circumstances, the Bank cannot change its policy, despite the risks mentioned by Olivier Klein (see above).

The ECB therefore still faces the same problem, namely that it is admittedly fulfilling its mandate by driving savings rates down, by reducing borrowing rates, by escaping the liquidity trap, and by reducing the rate differentials between the northern and southern countries in the eurozone. But as there is one interest rate, it cannot increase it, as the southern countries are still catching up. It can however play on the latest provisions of the CRD4 directive putting in place prudential macro measures (Ed: Directive 2013/36/EU of 26 June 2013 transposing the international agreements known as “Basel 3” into European law, including a strengthening and harmonising of capital requirements and introducing liquidity standards for the banking sector, then transposed into French law by the government order of 20 February 2014).

From a macro-economic point of view, the Bank cannot change its policy, at least not in the next two years. On the other hand, Lemoine said, in the event of overheating, it will use other instruments such as limiting loans to businesses for certain banks. In France, for example, the High Council for Financial Stability (HSCF), in its opinion delivered in December 2017, consequently said banks in the French system should restrict their lending to the most heavily indebted large companies, considering “as a first step” banning large banks from exposure to such companies in excess of 5% of their capital (cf. Bulletin Quotidien of 18/12/2017). But that is as far as that exercise will go, she believes. Here again, the ECB is moving away from its role by acting such that it is no longer the interest rate that determines changes in lending patterns, but macro-prudential measures established opaquely, which will now have to be taken into account.

In fact, there is no common definition across all eurozone member states that would enable such measures to be triggered. It is a matter of interpretation, left to the discretion of each member state. Lemoine was sorry to say this is an abuse of monetary policy. But in so doing, the ECB can meet all its objectives and therefore keep interest rates low while believing it has resolved the problem of financial bubbles mentioned earlier, Lemoine concluded by saying.

Political challenges

The European Central Bank is facing challenges of a political as well as technical nature.

The ECB is basically following a policy of redistribution. Tension between pensioners and young people is clearly seen, in Germany especially. This is because negative interest rates are in fact an additional tax on savings. In Mathilde Lemoine’s view, this is hazardous for central banks because it reduces their independence from governmental power, involving them in a policy of wealth redistribution which is obviously way beyond their remit, even though the ECB itself believes it is acting within its remit as it is pursuing its monetary policy objectives.

The second challenge is posed by asset purchases, and in particular sovereign debt and corporate bonds. The impression is given, totally wrongly, that the price of French and Portuguese government bonds is high. This by the same token changes the relative price of these assets. Central banks encourage investment in them while that does not tally with the reality of the returns from the investment made. In particular, the illusion is given of high demand for Portuguese bonds, regardless of the country’s growth potential. Similarly for Italian bonds, whereas it is known that Italy’s growth potential is nil from a macro-economic standpoint.

In the same way, by buying corporate bonds, the ECB distorts market competition. According to research by Edmond de Rothschild Group, the central bank is seen to be buying mainly French company bonds, and in particular bonds issued by utilities. The ECB reduces these firms’ risk premium which can consequently finance themselves with little effort.

The ECB, meanwhile, believes it has a quantity objective so as to increase its balance sheet and push inflation up, so that real rates continue to drop for such investments. However, the macro-economic analysis highlights the appearance of market distortion and the risk of misallocation of resources. This allows companies in these sectors to restructure, but slowly. On the other hand, it prevents financing being allocated to companies that could support potential growth, such as technology outfits. Utilities attract more than 26% of the ECB’s corporate bond purchases, for no less than €131 billion at December month-end 2017. In contrast, tech sector bond purchases accounted for just 1.6%.

There is accordingly a glaring discrepancy between discourse on the importance of innovation and the reality of a macro-economic monetary policy that results in cheap financing of firms that might be obsolete, with low productivity. In brief, it could be said the European Central Bank is driving industrial policy, pointed out Mathilde Lemoine.

On this point, Olivier Klein does not feel these effects much because their main sensitivity is to major companies, in his view. As regards innovative companies, they first and foremost finance through equity or through the stock market, and very little through debt, because they are in the red a long time.

Mathilde Lemoine, meanwhile, concluded this point thinking that if the ECB conducts a policy of redistribution and makes industrial policy, there is a real risk its of actions becoming political and of its losing its independence. In the worst case, it could have consequences on inflation expectations, namely the idea that inflation will accelerate in an uncontrolled way. This could have unintended effects on mid-term growth, she warned.

Technical challenges

The term “standardisation” is bandied about in public debate, investors implying we can return to a pre-crisis situation. Lemoine says this is technically impossible for a number of reasons. Firstly, because of the new regulations imposing increased requirements for high quality assets on the banking system (Basel III agreements). As a consequence, central banks in Europe will have to have assets on their balance sheets to provide liquidity on the inter-bank market. Under these conditions, central banks’ balance sheets returning to pre-crisis states is inconceivable.

Another technical constraint is very specific to the ECB which holds an asset portfolio, in particular bonds issued by utilities and sovereign debt with very low yields of 0.7%, compared with the Fed’s 3%. The central bank consequently has very little, or no, room for manoeuvre to put interest rates back up. Otherwise, it will make losses because it will have to remunerate bank deposits, which will go hand-in-hand with a lower balance sheet yield. In the euro-system, in addition, domestic central banks hold stocks as part of their balance sheet. The situation is therefore different from one central bank to another. Ultimately, it is a genuine technical challenge which makes it difficult for the ECB to raise its rates. The effects on the balance sheets of domestic central banks will vary greatly from one country to another, with a risk of losses for which both the Bundesbank and the Bank of Ireland have decided to make provisions. The risk is therefore not purely theoretical.

Lastly, the third technical constraint is the rise in indebtedness. Since 2000, corporate debt in the eurozone has climbed an average of 27 GDP percentage points to 133% of GDP in the first quarter of 2017, according to the ECB. Household debt, meanwhile, rose 20 GDP percentage points, admittedly slightly down in recent years, mainly because of Spain, but is nonetheless 94.2% of GDP. Here too, as with government debt, if the ECB increased rates, it would cause a recession. Taking the French deficit, since 2012, 40% of the reduction has come from monetary policy, not political will.

In conclusion, Mathilde Lemoine was keen to point out, the term “standardisation” should not be misjudged, and neither should a slight increase in lending rates. The ECB’s own policy gives rise to technical challenges that lead it to drive forward and therefore to have an ever-greater impact on the major macro-economic variables, and on the relative price of assets in particular. However, this can have negative consequences on growth potential because it leads to resource misallocations and distortions in market competition.

Converging views on the need for the ECB’s accommodative monetary policy, but a differing assessment of the effects of redistribution and sector impacts

At the end of the discussions, while Olivier Klein and Mathilde Lemoine diverge somewhat in their respective analyses of the potentially perverse effects of the ECB’s monetary policy as regards redistribution and sector impacts (see above), both agree on the other hand in recognising that this accommodative policy was nonetheless necessary when the risk of deflation and the risk of the eurozone disintegrating loomed large, Klein said, summing up the round table.

The need was pressing, he added, welcoming the arrival of Draghi at the helm at the right time. However, if we do not get out, the risk zones mentioned earlier would be created, including one in particular linked to the need to have to reload economic policy. Yet for now, there is practically nothing left to give in terms of monetary policy, nor in terms of budgetary policy given the level of public deficits and debts. So, during the next crisis, without reloading the weapons of economic policy, the situation will be critical, he warned.

But now, the question is not so much agreeing on the need to leave the ECB’s accommodative policy behind. The issue is different, Lemoine concluded, because monetary policy, as it has been conducted, means that in any event, the pre-crisis position cannot re-occur. Our way of understanding our economic environment must incorporate this new new set of circumstances and challenges posed. Consequently, we should be careful what we mean by “standardisation” and “recover”. Increasing rates is one thing. That does not mean, however, that the ECB will no longer intervene in setting asset prices, she said.

Lastly, she emphasised that one macro-economic truth should be remembered, namely that if rates are low, growth prospects are weak. At any given point, the central bank has less ammunition in the event of a crisis. However, central banks believe that to get the same growth rate as before the crisis, the balance of interest rates is now lower. For example the Federal Reserve, no later than September 2017, decreased its estimated long-term “neutral” interest rate from 3% to 2.75%, for the same level of potential growth. It did so because with an ageing population, the view is there is an excess of savings. Here too, for monetary policy to have the same effectiveness as pre-crisis, the lower increase is needed. All central banks worldwide consider that the neutral rate (the level where rates balance) is lower than before the crisis. Lemoine sees this as the most theoretical argument supporting the common conclusion of the need for a gradual increase in rates.