Tag: Policy-Mix

How could a “green” stimulus save growth in Europe?

Selin Ozyurt

Dear all, as promised, here is the English (and slightly longer) version of my article published in Le Monde – Selin Ozyurt : une relance « verte pourrait apporter le soutien tant attendu à la croissance européenne » . I hope you enjoy reading it!

In a context of weak growth outlook and inflation, the European Central Bank (ECB) announced in September 2019 new monetary stimulus by cutting the policy interest rates further and relaunching the net asset purchase program. Christine Lagarde, President of the ECB since November 2019, also suggested at her first press conference that the institution would play a key role in fighting global warming. So what role could the ECB play in 2020, while the global economy is slowing down unexpectedly and the climate emergency requires prompt action?

In the aftermath of the 2008-2009 global financial crisis, the enlarged toolkit of central banks has certainly helped to combat the danger of deflation. Yet, the effectiveness of additional monetary stimulus becomes questionable when rates are already close to their lower bound. The potential negative effects of low (and negative) interest rates are being openly discussed now, ten years after their first implementation. So, why are the interest rates still low despite their negative side effects on the economy?

The primary cause of historically low interest rates would be excess savings, reflecting greater risk aversion after the crisis in 2008 and the ageing of the population. According to American economist Larry Summers, the slowdown in productivity and low population growth reduced the growth potential of our economies over the past decades (i.e. secular stagnation hypothesis).

This leads us to wonder why productivity has been so low in advanced countries since the crisis. Underinvestment in the face of financial deleveraging needs, by governments and also the private sector, would be the usual suspect to explain the weakness of productivity. Stanley Fisher (Blackrock 2019) points out that lack of investment in infrastructure, education, renewable energy and digital technologies would limit potential growth and prevent TFP from returning to pre-crisis levels. Surprisingly, almost half of business investment decisions in the European Union (EU) would be hampered by inadequate transport infrastructure and lack of access to digital infrastructure (Boone and Buti 2019).

Vicious circle between low interest rates and low productivity

Interestingly, low interest rates may not only be the symptom but also the cause of the productivity problem. Recent research (Bergeaud et al. 2019; Gopinath et al. 2017) find that with low interest rates, a large number of unproductive firms and projects became artificially “profitable”. Accordingly, only a large technology shock would trigger enough productivity gains to get our economies out of this negative spiral.

With impending environmental challenges, failing investment in advanced economies become even more problematic in the medium term. Briefly speaking, the consequences of climate change are likely to weigh more heavily on our economies in two essential ways:

1) Further slowdown in labour productivity with increasing average temperature.

2) The destruction of productive capacities due to natural disasters.

In short, reducing CO2 emissions in entire sectors such as energy, industry and transport will require more and, above all, different investments.

“Explosive Cocktail”

Facing the “explosive cocktail” of economic and environmental challenges, a judicious combination of fiscal, monetary and structural policies (“policy mix”) becomes necessary. As Mario Draghi reiterated several times, there is significant fiscal space for stimulus in some euro area countries (e.g. Germany, the Netherlands, Austria). More generally, the positive differential between the real interest and economic growth rates offer a unique window of opportunity for fiscal accommodation, while preserving public debt sustainability.

One could also speak of a “green policy mix” in the light of recent announcements by European decision-makers. The new European Commission has presented its “Green Deal“, a green pact to achieve carbon neutrality by 2050. Yet, given the massive size of the challenge, the Green Deal should mobilise substantial budgetary, both at the EU and Member States levels.

Regarding monetary policy, Christine Lagarde stressed that climate objectives should be integrated into the ECB’s strategic review. Importantly, supporting the EU’s economic policies is part of the ECB’s mandate, as long as this does not undermine the primary objective of price stability. Thus, the ECB could already ally with the new Commission, in particular by ensuring that green projects benefit from favourable financing conditions. Although green securities have already been purchased under the ECB’s asset purchase policies (CPSP and PSPP), their volume remains very limited for the time being.

Greening the ECB’s balance sheet

As part of the “green policy mix”, Greens Bonds could become the central financing instrument for green projects and the European Investment Bank, the real financial arm of the Green Deal. The European market for Green Bonds is still in its infancy at the moment. Hence, the EU could increase the depth of this market by feeding it directly, but also through regular and large scale emissions from member states. A deeper secondary market for green bonds would allow the ECB to purchase larger amounts of green bonds and thus lower their yields, while respecting the imperative of market “neutrality”. Moreover, these purchases of green bonds will gradually make the balance sheet of the ECB greener, which is currently far from being CO2 neutral.

Finally, to ensure its effectiveness, the duration of this expansionary policy should be announced as soon as it is introduced, In addition, it is essential that the private sector takes over to play a central role in the energy transition of our economies takes over in the medium. This greening, through the investments in infrastructure and innovation it induces, could meet the technological challenge and stimulate productivity gains. Put differently, this “green” cooperation could ultimately get our economies out of secular stagnation and provide much-needed support to growth.

Brexit woes & the UK economy: Which policies to damage control?

Selin Ozyurt

#Brexit Facts

­Brexit implies heavy consequences for the UK economy at least in the short and medium term. For the moment, I will stop dwelling on the reasons why Brexit is economic suicide and discuss policy actions to mitigate its adverse impacts.

Let’s have a quick look at the state of the UK economy, exactly a year after the Brexit vote:

  • Low growth & high inflation: The UK economic growth slowed down in 2017 amid high uncertainty of Brexit negotiations, low investment and consumption spending. Inflation stood at 2.9% in May 2017, well above the 2% policy target of the Bank of England. High inflation was mainly driven by rising import prices (e.g. raw materials, energy, food) as a result of pound depreciation. Rising inflation had the consequence of decreasing the real earnings of the UK households.
  • High consumer debt: As a response to a stricter regulation of mortgage lending, the UK credit institutions  have been expanding their unsecured loans in 2017 . Thus, credit card lending and car finance grew at pre-crisis levels. More worryingly, the UK household saving rates declined to historically low levels in 2017. Precautionary savings serve as a cash cushion for households during ‘bad times’. Put differently, high debt and low savings make the UK consumers more vulnerable to economic/financial shocks during these uncertain times.

Brexit constitutes a major challenge for the UK policy makers. Since the economic crisis in 2008, the Bank of England has followed an accommodative policy stance (low interest rates + Quantitative Easing) to support economic growth. However, almost a decade of historically-low interest rates and unconventional monetary policy measures have rather contributed to building-up debt, both public and private, and asset-price bubbles in certain sectors. All in all, without the support of the economic policy (which was rather stuck in austerity), loose monetary policy was not enough to create the necessary conditions for a truly self-sustaining economic recovery.

The Bank of England’s next interest rate decision is scheduled on August 3rd. In a context of rising inflation and slowing growth, the Bank is facing an uncomfortable decision. The members of the Monetary Policy Committee expressed mixed opinions on whatever or not to start raising policy interest rates already.

Clearly, increasing inflationary pressures should be not ignored for long time to prevent the de-anchoring of long-term inflation expectations. In this sense, an interest rate hike could support the exchange rate of the pound and put the break on rising import prices. However, considering the ongoing fragility of the UK economy, raising interest rates ‘too soon’ may have disastrous consequences in terms of economic growth and household debt sustainability. For instance, high interest rates may further depress internal demand (investment and consumption) by making bank credit ‘too expensive’. Furthermore, most mortgage loans in the UK are contracted at variable or short-term fixed rates. Therefore, even a small rise of interest rates could make monthly mortgage payments more expensive, putting household budgets under increased pressure.

To my opinion, an interest rate rise already in August might be ‘too early’ in an environment of “anaemic” wage growth and Brexit uncertainty. Therefore, I believe, macroprudential measures could be more effective in tightening credit growth without endangering the economy. For instance, on 27 June, the Bank of England introduced higher capital requirements for major credit institutions. In other words, banks will have to put more capital aside for new lending. This was a good step in the right direction, in order to tame consumer credit growth without putting ‘debt sustainability’ under stress.

Of course, monetary policy cannot tackle all alone  the Brexit woes of the UK economy. The UK needs a good ‘policy-mix’ of gradual and timely monetary tightening together with fiscal expansion in the form of public investment in productivity-enhancing infrastructure. Since decades, the UK lacks a coherent and long-term strategic vision in infrastructure investment. Compared to the peer economies, the UK is ‘singled out’ because of its poor infrastructure in transport, telecoms and energy sectors. More importantly, the infrastructure deficit of the UK is detrimental to growth and largely explains the poor productivity of the UK industry.

The UK public debt is currently at historically high levels and the country has almost no fiscal space to introduce expansive fiscal policies. Obviously, addressing the UK’s deficit in infrastructure requires private-sector capital and expertise to complement public policies, which have failed so far.

I hope you found this article helpful. Please leave me a comment for your feedback and questions.