More A Whimper Than A Cry

Well the G7 meeting has come and gone, but I’m not sure how much the world is going to notice the fact. If I had been a fly, perhaps I would now be glad I hadn’t wasted my efforts. Basically there is a ‘shift’ from focusing on the oil issue to the inflation one, but given that in the two countries which are now driving global growth – the US and China – inflation is coming slowly but surely under control, I would have thought that this was to start to fall behind the curve instead of getting out in front of it. Put another way, since I am sure the Fed will push on through with the measured pace till the last drop of inflation oil is squeezed out of the US economy, I sure as hell don’t imagine that inflation is going to be tomorrow’s issue, and I guess this is the bit that the markets are really interested in.

Finance ministers and central bank governors from the world’s leading economies have warned of increasing inflationary pressures, adding to concerns over rising protectionist sentiment and global trade imbalances….The warning on inflation came as the US Federal Reserve continues to tighten monetary policy and follows the European Central Bank’s quarter point rate increase last week – the first in five years. The Bank of Japan has also started to prepare the ground for an eventual curtailing of its exceptionally loose monetary policy.

I think, btw, that the G7 are right to stress the importance of higher oil prices in the longer term as a constraint on the consumer, but this is ultimately a terms of trade effect – final consumption in the OECD world is squeezed as petro dollars mount up elsewhere – rather than an inflationary one as long as the monetary authorities keep the lid on ‘second round effects’. If you wanted to be really cynical you could say that the US government deficit was working as a giant paddle to keep the flow of funds moving, converting all those accumulated petro dollars into final consumption, but somehow I doubt Brad Setser would want to see things like this.

On Un-Common Ground

Now just remember, you read about it first on Afoe. Bertrand Benoit and David Pilling have an excellent article in the FT today:

Question: Which of the world’s biggest economies is holding an early election this month dominated by debate over radical economic reforms?

Two clues: The economy, long in the doldrums, is showing signs of life, thanks to improving exports and a restructured private sector. An ageing population is making structural reform an urgent priority.

The answer: Not one, but two countries – Japan and Germany.

Just my point in my earlier post, and the more this connection is recognised the sooner we’ll enter the zone of framing meaningful solutions. As the FT writers suggest, there are many intriguing parallels between next Sunday’s Japanese election and the German ballot one week later.
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Something Worries Me About Peter Bofinger

Really I realise I have been remiss in another important sense. I have long assumed that in fact the decision to reduce deficits was taken due to the coming fiscal pressure from ageing. This certainly was the background to the discussion. However now I look at the details of the SPG this area is not mentioned (as far as I can see) and the other – the free rider and associated – is the principal consideration.

So those who criticize the bureaucratic and infexible nature of the ECB are in the right to this extent. Of course the underlying demographics *should* be part of the pact, but that is another story.

I find myself in a tricky situation, since I am deeply sceptical that the euro can work, and now after the French vote even more so, but since it has been set in motion, the best thing is obviously to try and make it work (even while doubting). So I am thinking about all this. Obviously I should try and write a longer post making this clearer.

The SGP was adopted at the Amsterdam Council 1997. A history of the implementation of the pact, and a summary of the debate over the new pact can be found here. The Stability and Growth Pact was designed as a framework to prevent inflationary processes at the national level. For this purpose it obliges national governments to follow the simple rule of a balanced budget or a slight surplus.

Now if we go back to the origins of the pact, to the communication of the European Commission on 3 September 2004, you will find the following:

“As regards the debt criterion, the revised Stability and Growth Pact could clarify the basis for assessing the “satisfactory pace” of debt reduction provided for in Article 104(2)(b) of the Treaty. In defining this “satisfactory pace”, account should be taken of the need to bring debt levels back down to prudent levels before demographic ageing has an impact on economic and social developments in Member States. Member States’ initial debt levels and their potential growth levels should also be considered. Annual assessments could be made relative to this reference pace of reduction, taking into account country-specific growth conditions.”

Now curiously I have found nothing in Bofingers argument which seems even to vaguely recognise this background.

A good starting point for this topic would be the conference “Economic and Budgetary Implications of Global Ageing held by the Commission in March 2003.

The European Council in Stockholm of March 2001
agreed that ?the Council should regularly review the
long-term sustainability of public finances, including the
expected strains caused by the demographic changes
ahead. This should be done both under the guidelines
(BEPGs) and in the context of the stability and
convergence programmes.?

This document on the history of EU thinking on ageing and sustainability is incredible.
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Oooops It Isn’t Baaack….

Morgan Stanley team members Steven Jen and Eric Chaney (joined by Takehiro Sato and David Miles) debate today the interesting question of whether the eurozone economies have entered a liquidity trap (LT). Those who have no idea what one of these would look like could do worse than read Paul Krugman’s classic article on the topic: It’s baaack! Japan’s Slump and the Return of the Liquidity Trap (pdf).

So what is all the fuss about?
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Sweden Acts On Interest Rates

Well Sweden has just put the cat among the pigeons. Taking advantage of its ability to apply an independent monetary policy, the Riksbank has decided to cut its base lending rate from 2.0% to 1.5%. The reason why is not hard to discern, apart from the reduced growth forecast for this year, the inflation rate is falling dangerously low, at just 0.2% year on year in May, dropping from a 0.4% y-oy in April and 0.5% y-o-y in March. Obviously Sweden is on deflation alert, and in fact a greater reduction (say 1%) might have been justified.

This is bound to spark all sorts of additional debate about the euro, and its advisability. Finland would be the best point of comparison here. The Finnish inflation rate was 0.6% y-o-y in May, but it has been hovering precariously near the zero level for the last month, anything which gave a sudden push to the disinflation process, like a sudden bust in commodity prices, would certainly clearly knock Finland over the line.
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The First Chink of Light

There is a very interesting article in todays Financial Times. For the first time an executive board member of the ECB – Lucas Papademos – has spoken openly about the difficulties presented by having a single monetary policy for such a diverse set of economies. In fact these comments take on more significance in the light of the fact that Papademos is vice President of the ECB, and widely tipped to replace Otmar Issing as Chief Economist when Issing retires.
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‘Gloom’ After French Vote

The Washington Times (of all places) carries a UPI text about a Deutsch Bank research note on the economic consequences of the French ‘no’:

France’s rejection of the European Union constitutional treaty by a majority of 54.9 percent is a severe blow to European integration and threatens to depress European economy back into eurosclerosis as in the 1980s, warns Deutsche Bank in a research analysis published Monday.”
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Crisis Looming At The ECB?

A right royal row is brewing at the ECB. Basically the old guard theorists of the ‘one size fits all’ monetary policy are being challenged by more pragmatic observers of day to day realities. For the moments it is the politicians who are making the running (but there are plenty of competent economists in Germany and Italy who are ready to back them up), and yesterday the OECD joined the fray.
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An Asian IMF?

Yes, that’s what Bloomberg’s William Pesek suggests we might see evolving. As Pesek notes, the creation of an Asian Monetary Fund would:

“have major consequences for the global elites and the so-called “Washington Consensus” on how developing nations should go about raising living standards for their swelling and often poor populations.”

In particular, if this came off, not only would we be talking about a European social model, we would also be looking at an Asian one.
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