Panel intervention by Bank of Greece Deputy Governor John (Iannis) Mourmouras at the Concordia Europe Summit
07/06/2017 - Speeches
Remarks1 by Bank of Greece Deputy Governor John (Iannis) Mourmouras at a panel entitled “The political economy of the European Union” at the Concordia Europe Summit, held in Athens, on 6-7 June 2017
Your Excellencies,
It is an honour to be here today and I would like to thank the organisers for the kind invitation to the first Concordia Europe Summit, held outside of the United States in the cradle of democracy, the historic city of Athens. I propose to focus on monetary policies and, inter alia, talk about the issue of deflation as a relevant concern for the European Central Bank and EU Member States. With so many global leaders around the table, I would like to start by offering my insights from a global perspective.
Leaving behind us the second worst global financial crisis of the last century and its significant fallout around the world (economic stagnation, high levels of unemployment, a widespread risk of deflation, etc.) and, sooner or later, all the relevant policy responses including fiscal austerity and unconventional monetary policies, a new global economic policy agenda is taking shape, determined, among others, by the UK’s decision to leave the European Union (Brexit), a differentiated policy framework in the US, the rebalancing of the Chinese economy, divergent monetary policies and a declining role of globalisation.
2017 will be a good year for global growth (2017: 3.5%, 2018: 3.6%, 2016: 3.1%) both for emerging market economies (EMEs) and advanced economies. In particular, growth in the eurozone was more than twice faster in the first quarter of 2017 than in the US and this strong growth performance (around 1.8%, with upside risks) has a self-sustaining quality because it is driven not only by exports, but also by investment and consumption. However, it is still early days to conclude that this is the beginning of a period of rapid and sustained growth for the world economy. Many analysts point to a number of downside risks indicating a cyclical recovery and a rather temporary upswing, among others:
i) Political risks, triggered by a protectionist tit-for-tat, which may lead to a breakdown in cooperation and even open conflicts among great world economic powers.
ii) High levels of public and private debt and non-performing loans (NPLs).
iii) Negative global side effects stemming from a continuous rebalancing of the Chinese economy (e.g. credit constraint-induced lower growth rates).
iv) And, last but not least, EMEs’ underlying vulnerabilities exposed further by higher US interest rates and a rising US dollar. We are experiencing today a stronger dollar than the ‘strong dollar period’ of the early 1980s. Indeed, the US dollar’s annual rise over the last two years was 11% annually, compared with 7% in the 1980s between November 1978 and March 1985.
Focusing on the risk of deflation in Europe, ECB President Draghi declared victory against deflation last March in Frankfurt. He also said that the ECB has decided to change its forward guidance, namely the ECB does not anticipate that it will be necessary to lower rates further. Strictly speaking, we should rather talk about low inflation rather than use the D-word (the D-day was yesterday!). It is true that in February 2013, euro area inflation fell below the 2% mark and has since been on a continuous downward trend for more than 4 years but, on the other hand, the risk of deflation has been quite low all along in the euro area, for instance in contrast with Japan. At the start of the QE programme, the risk of deflation was just 10% in the short term (for a period of one to two years) and effectively zero (1% risk) in the longer term (within a period of five years).
Over the last 5 years, the challenge is to pull inflation up. What is perhaps a more worrying feature is the fact that the euro area stands among large economies (excluding Japan) in terms of the depth and likely duration of its low inflation. Core inflation has been below 1% over the past 4 years, with the lowest reading at 0.6% in March 2015, the lowest level since the start of the series in 1997. Core inflation today stands at 0.9%, while headline inflation stands at 1.7% due to the recent rise in the price of oil. The euro area needs accommodative monetary policy: inflation has been and always will be a monetary phenomenon, so combating low inflation requires monetary policy. In technical terms, this means quantitative easing, credit easing and even negative nominal rates. It is true that there is positive evidence from QE, mainly from the M3 growth rate and the banking sector, such as the growth rate of loans and reduced fragmentation. Since the launch of the QE programme in March, the euro depreciated against the dollar by 6% (devalued by 25% in the last 2.5 years), while it fell to a 14-year low on 26 December 2016 at 1.04.
Looking ahead now, clearly at some point in time, sooner or later, there will be an end to these unconventional monetary policies. The crucial question will revolve then around timing and sequencing, namely ‘when these policies will end’ and ‘if tapering should come first and then be followed by a rate hike’ or the reverse. On the other hand, a premature normalisation of monetary policy (just like in 2008 and 2011), either in terms of interest rate hikes or in terms of proper tapering or according to the ECB’s preferred wording “orderly adjustment”, entails the following two risks: the first is the risk of a relapse, namely the ECB shouldn’t abruptly stop loose monetary policy as a result, for instance, of a temporary inflation spike and not supported by the economic fundamentals. The second risk is the risk of financial instability, once interest rates start to rise.
In the meantime, and my expectation for this to take place is during the second half of this year, the issue of divergent monetary policies may well arise and, more generally, spillovers from the expected monetary and fiscal policy shift in the US and from the global economic outlook, in general. For instance, we expect two more rate hikes from the Fed within the year and for the Fed to start shrinking its balance sheet, which stands now at $4.5 trillion, up by 400% since the start of the crisis in 2008, due to the Fed’s QE programmes. In terms of fiscal policy, so-called Trumponomics, namely dropping taxes, spending on infrastructure, will be an important market influence this year, with investors particularly interested in two things: the transition from announcements to detailed design and sustained implementation and outcomes, particularly when it comes to the mix between higher growth and inflation. The anticipation of a more active fiscal policy is based on the assumption that President Trump will reinvent the package of policies known as Reaganomics. It seems that there are two differences, however, between the Reagan and the Trump administration. Reagan was fortunate to take office in 1981, just after the second oil crisis tipped the economy into recession. President Trump, by contrast, makes his entrance at the tail-end of a mature, though fragile, expansion. Secondly, it is the issue of public debt levels. President Reagan started a long surge in public-sector debt. Yet gross public debt today at nearly 105% of GDP is more than twice its size when Reagan left office in 1989 - a level not seen before outside the context of war. In closing, one thing is for sure: during this transitory period towards a new equilibrium for the world economy, uncertainty is the new decisive parameter that will affect economic decision-making by governments and monetary policy authorities, as well as global markets.
Thank you very much for your attention.
1Prepared remarks at a roundtable debating the future of Europe with major representatives from politics and diplomacy, business and finance, among others: Senator George Mitchell (USA), US Ambassador Geoffrey Pyatt, British Ambassador Kate Smith, Ambassador John Negreponte (USA), and former Heads of State and Prime Ministers.