Opinion
Eurozone economy
The dangers for the eurozone are all too real
Italy is one focus of concern with its low potential
growth, large deficits and enormous public debt
NOURIEL
ROUBINI
A looming permanent rise in debt servicing costs makes
the risk of a ‘doom loop’ — between indebted governments and banks holding that
debt — higher in Italy than in the rest of the eurozone
Nouriel
Roubini JUNE 17 2022
The author
is professor emeritus at the Stern School of Business, NYU and chief economist
at Atlas Capital Team
Faultlines
in the eurozone are resurfacing. In response to a sharp widening of sovereign
bond yield spreads in Italy and other states, the European Central Bank held an
emergency meeting on Wednesday. Its governing council decided to work on
designing a new facility to address “fragmentation risk”, or the idea that the
effect of monetary policy on the 19 nations in the eurozone may vary widely,
with potentially destabilising consequences.
The dangers
are real. Italian long-term yields have surged from below 1 per cent at the
start of the year to above 4 per cent in recent days. But fragmentation risk is
not the only serious problem for the ECB. In recent months, inflation in the
eurozone has also surged above 8 per cent. This is at a similar level to the
US, but, unlike the Federal Reserve, the ECB plans to wait until next month to
start raising interest rates. This lag behind the Fed and other central banks
is due to a variety of reasons. There is more slack in labour and goods markets
in the eurozone than the US as the area’s recovery from Covid-19 has been more
sluggish.
Supply
shocks, including soaring energy prices and those of other commodities
following the Russian invasion of Ukraine, are a greater factor than excessive
aggregate demand in driving eurozone inflation. Wage growth is more modest than
in the US, and the rise in core inflation is smaller.
Supply
shocks that reduce growth and push up inflation present all central banks with
a dilemma. To prevent inflation expectations from getting out of control, they
should normalise monetary policy sooner and faster. But that risks a hard
landing of the economy, with recession and rising unemployment. If, on the
other hand, the banks also care about economic growth and jobs — as even the
ECB does, in spite of its single mandate of price stability — they may
normalise more slowly and risk de-anchoring inflation from its expectations.
The US and
the UK are currently at serious risk of a hard landing as the Fed and Bank of
England aggressively tighten rates. But this risk is at least as large, and
most likely greater, in the eurozone than in the US. The recovery from Covid
has been more anaemic in the region. It is more exposed to energy shocks from a
long war in Ukraine. And given its reliance on exports to China, it is also
more vulnerable to a slowdown of Chinese growth stemming from Beijing’s
zero-Covid policy.
Moreover,
the weakening of the euro that arises from the difference in ECB and Fed
monetary policies is inflationary. The increase in borrowing costs for the
eurozone periphery is larger. Some forward-looking indicators, such as German
manufacturing data, signal that the area may be heading for a recession even
before the ECB starts raising rates. All of this is happening as ECB hawks,
keen to raise rates sooner and faster, are gaining the upper hand in the
governing council.
The
eurozone suffers from weak potential growth and job creation. A hard landing
would not only exacerbate these problems but intensify market concerns about
debt sustainability, or fragmentation risk. The “doom loop” between indebted
governments and banks holding that debt, a feature seared into the minds of
many by the eurozone crisis a decade ago, would come back into focus.
Designing a
new facility to deal with fragmentation risk is easier said than done. ECB
doctrine argues that potentially unlimited purchases of some governments’ bonds
are acceptable only if widening yield spreads are driven by unwarranted market
dynamics. When poor policies rather than bad luck are the driver, ECB bond
purchases need to come with conditions attached. This is how the Outright
Monetary Transactions facility was designed in 2012 but no government requested
it because none wanted to accept the politically fraught conditions. Still, in
order to pass legal muster, any new facility will need to include something
along these lines.
The recent
widening in Italian and other spreads is not just driven by irrational investor
panic. Italy has low potential growth, large fiscal deficits and a huge,
possibly unsustainable public debt that has grown during the pandemic. Now a
permanent rise in debt servicing costs looms as the ECB withdraws its
ultra-accommodative policies. The risk of a “doom loop” is higher in Italy than
in the rest of the eurozone.
Next year’s
Italian elections may produce a rightwing coalition dominated by parties
bristling with scepticism about the euro and the EU. In practice, any new ECB
facility designed to rescue Italian bonds may come with conditions unacceptable
to the country’s new leaders — and to any other eurozone states under pressure.
Before this
week’s ECB meeting, executive board member Isabel Schnabel stated that the
bank’s willingness to deal with fragmentation risk had “no limits”. This echoed
former ECB president Mario Draghi’s game-changing “whatever it takes” statement
of 2012. But Schnabel also hinted at the need for policy conditionality when it
comes to offering support. Given the current volatility of financial markets,
one can expect they will further test the ECB’s ability to protect the currency
union by backstopping fragile eurozone states.
Sem comentários:
Enviar um comentário