“Policy reboot 2020?”

The key chart

Summary

Today’s 4Q19 GDP data confirms that the euro area (EA) is growing at its slowest rate since the ECB introduced expansionary measures in June 2014 (0.1% QoQ, 0.9% YoY).

The region remains trapped by its debt overhang and out-dated policy rules – a major policy reboot is long overdue.

The root causes are captured clearly by my Macro Perspectives analysis that incorporates (1) global debt dynamics, (2) money, credit and business cycles, and (3) financial sector balances in a consistent analytical framework.

Progress towards dealing with the debt overhang in Europe remains gradual and incomplete. The EA continues to display the characteristics of a “private sector balance sheet-driven” slowdown rather than a “structural slowdown”. In this context, it is unsurprising that unorthodox monetary policy measures (1) have been only partially successful, at best, and (2) have unintended, negative consequences for growth, leverage, financial stability and income inequality.

Last month, I introduced my balance sheet framework and applied it to the UK economy. There are two key messages from this framework that are applicable to the current EA situation:

• When the private sector is running a financial surplus in spite of negative/very low policy and deposit rates (see graph above), this is a strong indication that the economy is still suffering from a debt overhang
• Fiscal space, like debt sustainability, is at its core a flow concept, not a stock concept (see graph below)

Following from this (and deliberately simplifying a complex policy debate), when growth, inflation and inflation expectations are below target and when interest rates are already zero or negative, fiscal policy should lead with an expansionary stance and monetary policy should cooperate by guaranteeing low interest rates for as long as needed. In short, this is a very different economic context to the one that existed when the current fiscal policy rules were chosen.

Unfortunately, despite strong and repeated calls for fiscal stimulus by the ECB, fiscal policy is only expected to be moderately supportive in 2020. Rules, designed to address different challenges at different times, are preventing stimulus in counties where policy makers would like to spend more (Italy, Spain) and national policy choices are limiting policy expansion in countries that have room for further stimulus (German, Netherlands). This is compounded by the lack of a central fiscal capacity at the euro area level that could strengthen the ability to deploy fiscal policy, complementing monetary policy, in case of significant euro area-wide downside dynamics (see https://www.imf.org/en/News/Articles/2020/01/28/sp012820-vitor-gaspar-fiscal-rules-in-europe ).

Conclusion

Marco Perspectives frameworks illustrate why a major policy review that begins with differentiating between different types of recessions is required if the EA is to escape from the current debt and policy trap. The ECB has announced a review of monetary policy in the EA, but the need for a wider fiscal policy review/reboot appears more urgent, in my view.

I presented the investment implications of this analysis at “The 5th Global Independent Research Conference” in London earlier this month. Please contact me to dicusss these implications and for access to the detailed analysis behind the summary comments above.

chris@cmmacroperspectives.com