The Economics of the German VAT Hike

I am very happy to be back here at AFOE, if not only, for a brief one-stop guest post about the economics of the German VAT hike and more specifically how market commentators and analists might just be reading the German economy somewhat falsely at the moment in the sense that they are not taking into account the implications of the sustained and evolving process of ageing in the German society. Indeed as Edward noted just a few days ago here at AFOE we might actually be talking about a clash of paradigms or at least a clash between two ways of looking at and interpreting the economic data coming out of Germany and indeed of the entire Eurozone. There are consequently many venues on which this diagreement is fielded and an important one of these is the German economy and more specifically the significance of the VAT hike and below the fold I will give my view on this topic.
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Have Global Interest Rates Peaked?

With the ECB adamant that it will continue to raise rates this would seem to be the most untimely of questions, but there are now signs that this may well be the case.

Firstly this in Bloomberg today:

Federal Reserve to Cut Rates in 2007, Corporate Bond Sales Show

Thinking about refinancing your mortgage in the U.S.? Wait a year. Considering a certificate of deposit? Sign up now. While economists debate whether the Federal Reserve will cut its target interest rate for overnight loans between banks from 5.25 percent, investors have already decided the central bank will reduce borrowing costs next year. Nowhere is that clearer than in the market for floating-rate notes, whose interest payments rise and fall with central bank policy. Sales of so-called floaters are slowing for the first time since the Fed started raising interest rates in June 2004. They’ve fallen to $21.5 billion in September from a monthly average of $35 billion this year through August, according to data compiled by JPMorgan Chase & Co.

Now one swallow doesn’t make a summer, and it is early days yet, but take a look at ten year US Treasury Bonds:

U.S. 10-year Treasuries fell, halting a five-day rally, before a report today forecast to show consumer confidence gained this month.The gains ended on speculation yields at their lowest since March will deter some investors. The yield on the benchmark 10-year note rose 2 basis points, or 0.02 percentage point, to 4.56 percent as of 6:37 a.m. in New York, according to bond broker Cantor Fitzgerald LP. The price of the 4 7/8 security due August 2016 fell 5/32, or $1.56 per $1,000 face amount, to 102 15/32. Bond yields move inversely to prices.

So today we have nudged the yield back up a little, but the rate has been dropping steadily since March. And yesterday Bloomberg were being even more explicit:
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The “Teuro” Dissected

Did prices really go up when the Euro arrived? The public mind, or at least the dominant media discourse, says they did. The inflation indices say they didn’t, or at least the prices that did go up were outweighed by the ones that went down. This paradox may have been solved. Erich Kirchler, of Vienna University’s Institute for Economic Psychology, tells Der Standard how.

Kirchler formed three representative groups of volunteers, and showed them prices in Schillings, then in euros. One group’s price was exaggerated by 15%, one reduced by 15%, and a control group saw correctly converted prices. All three groups were convinced the prices had risen…yes, including the second group. When he repeated the experiment with wages, rather than prices, the guinea pigs were convinced the opposite was the case.

He theorises that two well-known cognitive biases are at work – irrational perception of risk (the difference between accepting €10 now, or a 90% chance of €90 later) and the salience heuristic (unrepresentative but extreme events are over-perceived).

I was in Austria for the introduction of cash Euros, and I recall not so much that prices went up, as that the standard sums of money one withdraws from ATMs (20, 50, 100 etc) were suddenly considerably more and hence it was easy to spend more. Everyone was convinced that prices went up, though. And the German-speaking press had been hammering the word “Teuro” (roughly: “dearo”) into the meme-pool for months before the switch. (Especially, of course, Bild Zeitung and the execrable Krone..)

Did Russia come out ahead in the gas crisis?

Expanding on (and slightly copying) my comments in Edward’s post below, I was really shocked to see the spin in the western coverage of the Ukrainian gas crisis. The part that didn’t shock me – just made me groan – is the spin of a western press that seems to have decided in advance that Russia must be the bad guy, so Ukraine must be the good guy. Russia may be the bad guy, but I don’t think is Ukraine is the good guy. From what I can tell from the press, Russian claims that Ukraine was siphoning off gas seem well founded – Russia had been complaining since summer about siphoning, Gazprom was willing to let third parties audit the difference between what was going into Ukraine and what was coming out, while Ukraine refused. Also, it seems that the Russians weren’t the only ones making allegations about siphoning. Yes, Russia’s intentions towards Ukraine are not honorable, nor is this some purely commercial conflict free of political meaning. But, that does not exclude the prospect that Ukraine was screwing Russia.

But what really surprised me was the claim that Russia was the loser here.
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Don’t Say I Didn’t Tell You!

Inflation in the eurozone is not about to spiral out of control. I have been arguing this for months now. The latest piece of evidence: French consumer prices fell 0.3 percent in November as compared with the previous month:

French consumer prices fell 0.3 percent in November on the previous month, national statistics office INSEE reported on Tuesday. That brought the annual rate of inflation down to 1.8 percent from 2.0 percent in October. The drop in consumer prices was largely driven by a 2.8 percent fall in energy prices, with petrol products down 5.1 percent.

Petrol, Petrom, and the President

So, President Basescu is unhappy.

This is not unusual. President Basescu is often unhappy. You’d think that, having won the election last December against Prime Minister Nastase, he’d be at least content. But Basescu is a scrapper, and he’s always looking for a fight, and in recent weeks he’s found one. It’s about petrol, and Petrom.

Perhaps I should explain.
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Issing Gives Inflation Warning

More evidence today of how the Central Bankers and their economic advisers are doing their best to sound the inflation alarm. This time it is ECB Chief Economist Otmar Issing:

European Central Bank Chief Economist Otmar Issing said a surge in oil prices may lead to higher-than- expected inflation in 2006, as the bank edges closer to raising interest rates for the first time in five years.

“Rising oil prices are not only affecting current inflation rates but they’re also overshadowing next year,” Issing said in an interview on Oct. 14 at a banking event in Frankfurt. “It can’t be ruled out that risks for price developments will deteriorate that much over the medium term that we might have to expect the annual inflation rate to slightly exceed 2 percent.”

The comments were the second in three days suggesting the bank may raise its inflation estimate of 1.9 percent for 2006. The bank projects the level this year at about 2.2 percent. ECB President Jean-Claude Trichet said at a briefing after the annual meeting of the Group of 20 industrial and developing near Beijing yesterday that he can’t exclude inflation being “over and above” the bank’s 2 percent ceiling.

My view: this very much depends on the evolution of oil prices. There is little evidence of any strong impact on ‘core prices’ at this point, there is plenty of evidence of growth weakness. There is thus little justification from a purely eurozone perspective for any short term increase in interest rates, and certainly no justification whatsoever in the case of Germany.

UK Jobless Upward Trend Continues

U.K. jobless claims rose for an eighth consecutive month in September, extending the longest period of increases in almost 13 years, “as growth in Europe’s second- biggest economy slows”. This adds just a little more evidence to the fact that all is not necessarily currently all for the best in the land of John Stuart Mill. However as NTC research point out, not all is totally bad either:

Meanwhile, annual average earnings growth held steady at 4.2 percent in the three months to August, signalling that higher inflation is still not feeding through to wages.

So earnings continue upwards at a healthy clip, but not above trend. No evidence of ‘secondary effects’ here then. Which makes you wonder why the normally reasonable Mervyn King is currently being so evidently unreasonable. You can find my explanation for this here (and in the comments).

Mervyn King on Tuesday night signalled he was not convinced of the case for lower interest rates and could see many reasons why the rise in oil prices might increase inflationary pressure.
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The French Differential

As I keep indicating the French economy – although not a spectacular success – continues to outperform the German one. This is interesting, since the French political system has been much more laggard than the German one in implementing reforms. That is why I place emphasis on the demographic differential.
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Just In Time?

Tony Blair inched home to a historic Labour third term in the UK last week. But looking at the changing tempo of the British economy over the last couple of months, you could be tempted to ask: was this a case of ‘just in time’ electioneering?

At the present time there seems to be a general consensus that Blair will back down during this parliament, and that the natural heir apparent is Economics Minister Gordon Brown. However if Blair won the election despite the Iraq war, and thanks mainly to economic prosperity, we could ask ourselves whether changing winds of fortune might not make the heir rather less apparent when the time for handing over actually comes.
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