Economic Consequences of Spain’s 11M

Italian consumer confidence has remained near a 10-year low in March in the wake of the Madrid terrorist bombings. In fact the bombings may have hurt sentiment in Italy more than the Sept. 11 attacks on the U.S. according to a statement from the government-funded Isae institute. The confidence survey, which was carried out between March 1 and March 12, showed that consumers who had been growing more optimistic about the prospects for lower inflation and improvements in unemployment turned pessimistic in the two days after the bombings. In fact while the 22-year-old Italian consumer confidence index touched its all time record low of 93.7 in April 1993, March was the third month in a row that the index has been below 102, the last time it was that low being in February 1994.

One significant factor which may be in the minds of Italian citizens today is that Italian Prime Minister Silvio Berlusconi has been – along with Jose Maria Aznar – one of the firmest eurozone supporters of the Iraq war. (Interestingly Klinga over at Living in Europe draws attention to the way a similar atmosphere may also exist in Poland). But this concern over the risk of a possible attack comes on top of an already weak confidence situation following an apparent economic growth standstill and the high profile Parmalat scandal.

The Italian confidence report is in fact the second from Europe to show the effect of the bombings. An index measuring German investor and analyst sentiment published last week posted the biggest decline in 16 months.

With exports affected by the 20 percent plus euro appreciation, economic growth in Italy ground to a halt in the final quarter of last year. Indeed Italian industrial production continued to decline in January for the second consecutive month.

The euro’s gain against the dollar, which has made European goods sold to the U.S. more expensive, has weighed heavily on any recovery which may have been in the offing in Italy. Exports to the U.S – which are responsible for 10 percent of Italy’s total exports (the US is its third-biggest trading partner) – fell 27 percent year on year in January2004.

Meanwhile in France, which is the second-largest economy in the euro zone, consumer spending was unchanged in February from the previous month, according to the Paris-based statistics office Insee.

All of this means there is increased pressure over at the ECB. Leading EU politicians like Gerhard Schroeder and Jean-Pierre Raffarin have been urging the European Central Bank to lower interest rates in an attempt to revive growth. ECB officials including President Jean-Claude Trichet have previously rejected the calls, saying that borrowing costs are already low enough.

The Madrid bombings, however, have increased speculation about a rate reduction. The implied rate on the three-month Euribor interest-rate futures contract for June delivery has it seem fallen today to 1.93 percent today from 2 percent on March 11. That rate is now lower than the ECB’s benchmark refinancing rate of 2 percent. The markets themselves have today responded to an interview Trichet gave to the German paper Handelsblatt yesterday (see below) by selling the euro in anticipation of a rate cute.

To give us an idea of where all this may be leading Handelsblatt has an English version of the Trichet interview. In the interview he suggests that the bank might be ready to cut interest rates if domestic consumption does not strengthen as expected. The ECB’s next rate-setting meeting is on April 1. Many commentators had thought that it was unlikely we would see any rate move in the near future. Now, given the shift in rhetoric, it seems that the Bank’s governing council members are at the very least likely to debate the issue.

You keep complaining about weak consumer confidence. Could lowering the interest rate help to prop it up?

In the normal course of economic activity, recovery most often starts with net exports, then passes over to investment and then, as the third stage of the rocket, so to speak, arrives at consumption. The first two rocket stages have ignited and we continue to follow the relevant hard data. We now have to examine very carefully the ignition process of the third stage. It is clear that household consumption is not only driven by the impact of stronger exports and investment, but also by consumer confidence. We have ascertained that consumer confidence today is not necessarily at the level that would be justified by the basic economic data.

Why is that?

I see three reasons. First, the development of the labour market is not satisfactory. This in turn comes from the structural impediments which characterise Europe and from the previous phase of the cycle. We have good reasons to think that this situation will progressively improve. Second, there is the unfortunate phenomenon that public opinion very often discovers the problems at the moment they are tackled, when governments, parliaments and social partners carry out the structural reforms that are urgently needed. This late and brutal discovery could have a negative impact on confidence. Had the public been more aware of the underlying problems, the reforms, when decided upon and implemented, would have increased confidence. That is the reason why we believe that transparency, pedagogy and tireless explanations are an essential part of preparing structural reforms: we all have a role to play in this domain, including the ECB, to make clear to people the advantages of the reforms as regards growth, job creation and higher standards of living. And third, there is a further point which touches upon the primary objective of the ECB. In a number of countries part of the population has the feeling that the inflation rate could be higher in the future and that their purchasing power will not be appropriately preserved. This has a negative influence on consumer confidence. We, on our side, have all reasons to trust that we have inflation under control and that prices will be in line with our definition of price stability. And we tell the public that we, as the guardians of the currency, are defending their purchasing power, that they can trust us and that they can invest and consume with full confidence.

This entry was posted in A Fistful Of Euros, Economics and demography and tagged , , , , , , by Edward Hugh. Bookmark the permalink.

About Edward Hugh

Edward 'the bonobo is a Catalan economist of British extraction. After being born, brought-up and educated in the United Kingdom, Edward subsequently settled in Barcelona where he has now lived for over 15 years. As a consequence Edward considers himself to be "Catalan by adoption". He has also to some extent been "adopted by Catalonia", since throughout the current economic crisis he has been a constant voice on TV, radio and in the press arguing in favor of the need for some kind of internal devaluation if Spain wants to stay inside the Euro. By inclination he is a macro economist, but his obsession with trying to understand the economic impact of demographic changes has often taken him far from home, off and away from the more tranquil and placid pastures of the dismal science, into the bracken and thicket of demography, anthropology, biology, sociology and systems theory. All of which has lead him to ask himself whether Thomas Wolfe was not in fact right when he asserted that the fact of the matter is "you can never go home again".

8 thoughts on “Economic Consequences of Spain’s 11M

  1. The economic will follow the political, perhaps:

    “But even more profoundly, the sudden electoral shift in Spain has revived stalled talks on the European Constitution and have made consolidation of a Eurostate able to counterbalance US power far more likely.”

    Long-term such a change in direction would have dramatically more economic impact than ECB rate fiddling.

  2. Hooboy! The translation to Jean-Claude Trichet’s coded language, for all you Americans and anti-Americans alike, can be summed up as this:

    The first stage of the rocket of economic recovery has ignited, because the US economy is on the rebound. The second stage has ignited, as European domestic investment has increased, because Europe’s own capitalists see that the US economy is on the rebound, thus fueling EU exports, and the key to EU economic recovery.

    The third stage of the rocket is faltering, because “First”: the cost of EU labor is still too high. “Second”… the politicians were slow to grasp the significance of this, and the necessity for reform, and the media delivers this message to the public when it’s way too late to do any good, and “third” – the public doesn’t want to spend money because they’ve lost confidence in the fact that the EU domestic economy is not recovering, because the media delivered the message – that the cost of EU labor (the welfare state) is still too high – too late, and that any reforms now would be too late to affect any further changes in the economic landscape.

    But “we, on our side” in the ECB (as opposed to the politicians, who don’t have the balls to confront labor, and other advocates of the welfare state), still trust in the price stability due to the American recovery, and will do our best to keep prices in line, despite the fall in value of the US dollar, making EU labor even more expensive.

    So y’all EUers can “trust us” and “invest and consume with full confidence”.

    That is about as reassuring as a transcript of a Calvin Coolidge speech delivered by Jimmeh Carter.

    When will Europe decide to become a real player on the economic field, instead of waiting for a free ride on the backs of the American people?

  3. “When will Europe decide to become a real player on the economic field”

    Unfortunately RSN you have, as seems to be your custom, missed the main point.

    The underlying reality is that neither Europe nor the EU are destined to be the real players in the big match that is to come. The key players to watch here are this seasons ‘revelations’: India and China.

    The EU and the US models are in big trouble for different reasons. The US model seems to be foundering on the consequences of the short sighted decision to allow the dollar to become the world reserve currency. The eurozone is experiencing ‘extreme discomfort’ due to the equally misguided attempt to avoid reform of the whole system and instead try to replace the dollar with the euro.

    The EU has in addition a much more acute ageing problem than the US, but even on your side of the pond pensions and social security seem to be threatened, at least if I am to believe Sir Alan Greenspan.

    The key quote from Trichet is this:

    “This late and brutal discovery could have a negative impact on confidence. Had the public been more aware of the underlying problems, the reforms, when decided upon and implemented, would have increased confidence.”

    Whilst I disagree with much of his diagnosis – he still thinks inflation is the real danger, I go with Bernanke, price stability would be a better objective, ie trying to avoid deflation – I think this warning is very important.

    I would take two issues: outsourcing and terrorism. In both cases we have policies which are not adequate to the task (on either side of the pond). We have lulled ourselves into thinking the poor can stay poor forever, and are thus not prepared for the global redistribution shock that is coming. And we are applying policies which in their one-sideness seem to be increasing and not reducing terrorism.

    So one day people are going to wake up to this, and the biggest danger is that they feel without protection and panic. This is what represents the fundamental economic danger, and here Trichet is absolutely right. Of course if you simply try to reduce this to a point scoring EU-US football match operation, if and when the show does go-off you won’t understand very much.

    Two parting shots: “the cost of EU labor is still too high”. This is an extraordinarily complex topic, but just let me say that the “cost of US labour is too high” too when compared with India, China or Bulgaria – obviously your wages are higher than ours and you do more or less the same work stateside as we do here. So let me get this straight: should we be reducing wages significantly on both sides of the Atlantic to get them into line with the new global reality? Is that what the US President who would win your backing should be advocating – wage cuts to overcome the sluggishness in the labour market?

    And lastly:

    “the US economy is on the rebound”,

    Don’t take this too much for granted. I don’t. And the US stock markets seem to be thinking long and hard about this right this moment.

  4. “and have made consolidation of a Eurostate able to counterbalance US power far more likely.”

    Unfortunately Patrick this is not my reading at all.

  5. Edward,
    that particular phrase is not where I’d personally put the emphasis, but I quoted the paragraph in its entirety rather than edit the last sentence to fit my particular tastes.

    more specifically, the Economist article quoted by Nathan had this:

    But the new Spanish government may influence the [E.U.] constitution in other ways. The Socialists favour pan-European tax harmonisation, for instance; one more reason for Mr Blair and the British to regret the passing of Jos? Mar?a Aznar.

    Changing the tax code can change the economic situation far more profoundly than interest rate changes

  6. Edward, fair enough. But I still see your criticism as an attempt to equate the status of the US and EU, when it still seems that the EU has allowed itself to become dependent on the US, to the detriment of both.

    India and China will indeed be the key new players in the field, but I see the US as far more flexible in accommodating these new entrants than the EU. The outsourcing debate is all the rage now, but there’s precious little that can be done to stop it, as businesses will follow their inclination to maximize the bottom line and pursue outsourcing. It’s just fodder for the campaigners at the moment.

    I certainly would contest the notion that Trichet did not refer to the US economy being on the rebound when he said “recovery most often starts with net exports”. That has been the traditional mode for European recoveries in the past.

    I look at the labor situation in the US, and I find too much hand wringing going on… in Europe. Back in my school days, we were taught that 5% unemployment was considered full employment. So if we hover now at 5.6 or 5.8, we’re still about .8% above full employment.

    When I mentioned the cost of labor in the EU, I specifically had certain employer costs in mind, due to the rigid labor laws, – not wages. So a clarification is in order.

    As to the stock market at this moment, well, as you know, no one has tea leaves to read on that, least of all European naysayers who are adverse to giving the market a dominant role in their lives.

    In terms of the fear factor affecting economies, I tend to doubt Trichet had terrorism on his mind when he made his comments. I think you are putting your own spin on that one. Terrorism, – and the approaches in fighting it – are viewed in a distinctly different way on the two sides of the pond. I don’t want to ennumerate all of them, but I would like you to mull on this: the aggressive US reaction can be seen as the right stance to take, if we were to have the US economy get back on the track of recovery, following a debilitating attack. That’s the difference in spirit between Americans and EUers. Americans must go and take action – whether wisely or not – in order for economic confidence to survive. The EU stance of absorbing blows and trying to minimize the rattle is simply not an option for American economic confidence.

    I share your views about India and China. I’m very optimistic about American-Indian relations. I’ve worked with Indians in Silicon Valley and I’m convinced that, in time, the two nations will be drawn more together, despite differences in the past. But I do worry about China, and the immense cultural gap. The common language of money is certainly understood, but that is where similarities end. There’s no sense of partnership when one deals with China, while Indians seem to fully understand the necessity of give and take for partnerships to survive.

  7. RSN,
    I look at the labor situation in the US, and I find too much hand wringing going on… in Europe. Back in my school days, we were taught that 5% unemployment was considered full employment. So if we hover now at 5.6 or 5.8, we’re still about .8% above full employment.

    If 5.0% is truly full employment, then how do you explain the four year stretch between ’97 and 2001 when the U.S. unemployment rate was below 5% ?

Comments are closed.