Thursday, November 27, 2014

Abenomics, European-Style

NEW YORK – Two years ago, Shinzo Abe’s election as Japan’s prime minister led to the advent of “Abenomics,” a three-part plan to rescue the economy from a treadmill of stagnation and deflation. Abenomics’ three components – or “arrows” – comprise massive monetary stimulus in the form of quantitative and qualitative easing (QQE), including more credit for the private sector; a short-term fiscal stimulus, followed by consolidation to reduce deficits and make public debt sustainable; and structural reforms to strengthen the supply side and potential growth.

It now appears – based on European Central Bank President Mario Draghi’s recent Jackson Hole speech – that the ECB has a similar plan in store for the eurozone. The first element of “Draghinomics” is an acceleration of the structural reforms needed to boost the eurozone’s potential output growth. Progress on such vital reforms has been disappointing, with more effort made in some countries (Spain and Ireland, for example) and less in others (Italy and France, to cite just two).

But Draghi now recognizes that the eurozone’s slow, uneven, and anemic recovery reflects not only structural problems, but also cyclical factors that depend more on aggregate demand than on aggregate supply constraints. Thus, measures to increase demand are also necessary.

Here, then, is Draghinomics’ second arrow: to reduce the drag on growth from fiscal consolidation while maintaining lower deficits and greater debt sustainability. There is some flexibility in how fast the fiscal target can be achieved, especially now that a lot of front-loaded austerity has occurred and markets are less nervous about the sustainability of public debt. Moreover, while the eurozone periphery may need more consolidation, parts of the core – say, Germany – could pursue a temporary fiscal expansion (lower taxes and more public investment) to stimulate domestic demand and growth. And a eurozone-wide infrastructure-investment program could boost demand while reducing supply-side bottlenecks.

The third element of Draghinomics – similar to the QQE of Abenomics – will be quantitative and credit easing in the form of purchases of public bonds and measures to boost private-sector credit growth. Credit easing will start soon with targeted long-term refinancing operations (which provide subsidized liquidity to eurozone banks in exchange for faster growth in lending to the private sector). When regulatory constraints are overcome, the ECB will also begin purchasing private assets (essentially securitized bundles of banks’ new loans).

Now Draghi has signaled that, with the eurozone one or two shocks away from deflation, the inflation outlook may soon justify quantitative easing (QE) like that conducted by the US Federal Reserve, the Bank of Japan, and the Bank of England: outright large-scale purchases of eurozone members’ sovereign bonds. Indeed, it is likely that QE will begin by early 2015.

Quantitative and credit easing could affect the outlook for eurozone inflation and growth through several transmission channels. Shorter- and longer-term bond yields in core and periphery countries – and spreads in the periphery – may decline further, lowering the cost of capital for the public and private sectors. The value of the euro may fall, boosting competitiveness and net exports. Eurozone stock markets could rise, leading to positive wealth effects. Indeed, as the likelihood of QE has increased over this year, asset prices have already moved upward, as predicted.

These changes in asset prices – together with measures that increase private-sector credit growth – can boost aggregate demand and increase inflation expectations. One should also not discount the effect on “animal spirits” – consumer, business, and investor confidence – that a credible commitment by the ECB to deal with slow growth and low inflation may trigger.

Some more hawkish ECB officials worry that QE will lead to moral hazard by weakening governments’ commitment to austerity and structural reforms. But in a situation of near-deflation and near-recession, the ECB should do whatever is necessary, regardless of these risks.

Moreover, QE may actually reduce moral hazard. If QE and looser short-term fiscal policies boost demand, growth, and employment, governments may be more likely to implement politically painful structural reforms and long-term fiscal consolidation. Indeed, the social and political backlash against austerity and reform is stronger when there is no income or job growth.

Draghi correctly points out that QE would be ineffective unless governments implement faster supply side structural reforms and the right balance of short-term fiscal flexibility and medium-term austerity. In Japan, though QQE and short-term fiscal stimulus boosted growth and inflation in the short run, slow progress on the third arrow of structural reforms, along with the effects of the current fiscal consolidation, are now taking a toll on growth.

As in Japan, all three arrows of Draghinomics must be launched to ensure that the eurozone gradually returns to competitiveness, growth, job creation, and medium-term debt sustainability in the private and public sectors. By the end of this year, it is to be hoped, the ECB will start to do its part by implementing quantitative and credit easing.

Read more from "Introducing Draghinomics"

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    1. CommentedLawrence Michael

      Let us look at some basics that some seem to touch upon but not articulate. For example the idea that an economy with a GDP of 50 trillion showing a 3% increase is doing worse than an economy with a GDP of 50 million showing an increase of 7% is obviously fallacious as anyone can see but usually read that fallacy in both reports as well as analytical pieces as this. The global economy is complex with any nth number of factors affecting the various players - with the finite nature of economy, human population and the planet earth being the three corner stones of recognitions one seems to easily escape in making such obvious fallacies so readable analytic pieces. The other aspect being - structural factors with attrition factors (they can be internal - citing Chandigarh as a city in Northern India as one sterling example of such attrition that show as degradation to the original idea as well as reality. They can be external - a bunch of simians landing up at NASA's Hubble Telescope site and operating it too). Both these factors affect the nature of supply & demand in both the senses: external as well as internal including the human/'cultural' factor that remains central to every human exercise and more so with economics. Globalization merely makes it more complex - with what may or can be controlled or even are! The word 'cultural' in quotes because we all do continuing debating over it including the anti-cultural that even then seek to claim the word culture without intending any pun. Keeping certain basic factors in mind does help in quantifying data more correctly than before, even when qualifying it as data always is both its basic types once again.

    2. CommentedGunnar Eriksson

      Remember that increased wages for ordinary people is a vital part of the prescription.
      There is no lack of capital but it is only looking for rent. Tax idle and speculative capital for public investment

    3. CommentedMukesh Adenwala

      To say the least, this is disappointing analysis. Established and forgotten wisdom claims that "you can pull a string but cannot push it." Lack of demand is on account of lack of employment, which in turn has been caused by technological advances - there is eminent argument that we are moving towards zero marginal costs. It has also been eminently argued that quantitative easing (or even QQE) pursued endlessly has no clear benefits. To hope that Animal Spirits would take care of the rest and till the time inflation becomes a problem we should continue to disregard it, fails to make sense. Perhaps it shows that in order not to admit another great depression, we continue to advocate and follow policies that have not worked these last six years.

    4. CommentedWillard Hoffer

      The solution to the debt problem is not more debt! The west has lived beyond its means for far too long and now it is time to suck it up and suffer the consequences.

    5. CommentedZsolt Hermann

      It is interesting that the author recommends a policy, that by the latest measures and reports is failing in Japan.
      It seems that any "gains" the "arrows" produced were simply cosmetic without any real life gains or improvements.

      Which is understandable since we can try to resuscitate, kick, repaint a dead horse but even if we ourselves try to carry it beyond reason, it is still a dead horse.

      There is no solution for the stubbornly pushed constant quantitative growth economic model and lifestyle in a vast natural system which is built on general balance and homeostasis.

      We cannot try to build an artificial human bubble based on excessive, exploitative over-consumption when the system we evolved from and still exist in is based on natural necessities and available resources.

      We cannot keep on competing with each other, succeeding at the expense of others and life, existence is based on mutually complementing cooperation, primarily working for the benefit, sustainable existence of the collective and only after for ourselves.

      We are very unique creatures, we are truly above any other lifeforms with a conscious mind capable of critical assessment, even self-change, but still we are only part of the system.

      We are not here to invent, create, establish a special human habitat above or against nature.
      We are here to adapt to the system in a conscious, self-aware,m dynamic way.

      Thus first we have to learn, understand the system, and then change ourselves, humanity according to it.

    6. CommentedPaul A. Myers

      It seems to me that the Hollande government of France is proposing just this sort of program. The missing piece is concerted action by the ECB at the eurozone level.