March 30, 2014 4:59 pm

Europe’s central bankers talk too much and act too little

By Wolfgang Münchau

It’s showtime and quantitative easing is the only big policy tool left to do the heavy lifting


It is five months since the sharp and persistent drop in eurozone inflation, and the gnomes in the European Central Bank’s governing council are talking and talking and talking.

They say things such as: there are no technical or legal obstacles to negative interest rates or quantitative easing. But they do not act. Sometimes there is a mercifully quiet day when only one of them opens their mouth. But last week we had five speeches or interviews on a single day. They sounded dovish. Or did they?
Some outside observers expressed confidence that QE – the “creation” of money through asset purchases that increase the size of the central bank’s balance sheet – was now more likely because Jens Weidmann, president of the Bundesbank, apparently moderated his language.

Others suspected a trick.

So why, one wonders, do the central bankers not simply shut up and act instead? My guess is that they will go for QE, but not now. I have heard the view that the ECB plans to wait until after the European parliamentary elections in May. I hope this is not the case. Allowing inflationary expectations to drop below target for political reasons would destroy the ECB’s credibility beyond repair. So they talk because they do not want to act. Talk is free. I know that some of them believe in the magic of verbal intervention – the central bankers’ equivalent of a free lunch. Tell the markets that your exchange rate is overvalued – and it magically adjusts. Just say the word.

On one occasion the trick worked. In the summer of 2012 Mr Draghi said he would dowhatever it takes” to save the euro. He constructed a programme around this promise: Outright Monetary Transactions. It cost nothing. Investors were assured that the ECB would never allow a eurozone country with reasonable policies to default. The interest rates on sovereign bonds have since dropped and stayed low.

It would be a mistake to extrapolate from this experience. OMT was not classic monetary policy. The judges on Germany’s constitutional court argued that it is not an act of monetary policy at all but a political intervention – a ruling I believe to be justified. OMT worked because it was political. Its credibility derived from the fact that it was tacitly supported by the German government.

The world of ordinary monetary policy, however, is very different. A central bank may be able to guide expectations by pre-announcing a policy. Even that fails more often than it succeeds. Just remember the havoc the US Federal Reserve created when it raised the issue of tapering last year. When you try to fool too many people for too long, they stop believing you. In the case of the ECB and the more verbose national central banks, I fear this may already have happened.

It has been going on for five months. In October last year, inflation fell like a brick – to a little under 1 per cent. Both the drop and its persistence surprised the ECB. It cut interest rates in November. Since then, it has just been talk.

On Friday Spain reported outright deflation. Even German inflation is at only 1 per cent. One often hears the phrase that we are one shock away from outright deflation. It would have to be quite a large shock for that to happen. The Ukraine crisis could constitute such a shock but probably not in the absence of an extreme escalation. But it is aggravating the situation. Money from Russia and other places is streaming into the eurozone, raising the real exchange rate of the single currency and reducing import prices.

While the good news is that outright deflation remains improbable, the bad news is that you do not need outright deflation to get into big trouble. A permanent cut in inflation expectations to current levels is all it takes. If eurozone inflation rates were to settle at 1 per cent, the odds of debt sustainability for several eurozone member states would change from small to zero. Inflation lowers the real value of debt. Deflation does the opposite.

Quantitative easing is the only big policy tool left to do the heavy lifting. It would lift inflationary expectations. It would accomplish this through different channels. One of them is to get banks to sell assets to the ECB, the proceeds of which they would use to lend to companies. Another channel would be a fall in long-term interest rates.

On my own calculations, the total size of such a programme would have to be well over $1tn – but that number rises with each month of inaction. Marcel Fratzscher, the director of Germany’s DIW economics institute, came up with a number of $60bn per month, which is in the same ballpark.

It is showtime. No more talk. And please, no doctored minutes of meetings of the ECB’s governing council either, an “innovationcurrently under discussion. It would only add to verbal overflow.

Instead, tell us that you have acted and why. Or, more likely, tell us that you have not acted, or have not acted enough, and why.

Copyright The Financial Times Limited 2014.


Freedom or licence?

Annuities are not as bad as they are sometimes painted

Mar 29th 2014


LET the pensioners free. That was the rallying cry of the recent British budget, which decreed that those who accumulate a pension pot no longer must use the proceeds to buy an annuity on retiring.

The change will bring Britain into line with America and Australia, where those retiring have immediate access to their pension pots. But Canada, Singapore and Sweden still impose fairly tight restrictions on what they can do with their money, as do Denmark and the Netherlands, two countries with widely-admired pension schemes.

Many people believe annuities, which transform a pot of cash into regular payments until the beneficiary dies, are a bad deal. Certainly, the failure of Britons to shop around for the best rate when they retire (the so-called open-market option) means that some lose out. But the two main reasons why annuity rates have fallen are fundamental; first, people are living longer and second, the general level of interest rates has fallen.

Pensioners exercising their new-found freedom need to take account of both factors. In 1960 British males who reached the retirement age of 65 could expect to live a further 12 years; now it is almost 19 (and 21 years for females). The income from any given pot has to be lower because it needs to last longer.

Meanwhile, interest rates are low because central banks are worried about the health of the Western economies; thanks to deteriorating demography, we may have moved to a slow-growth, low-rate world.

Think of an annuity as paying the equivalent of the market’s risk-free rate. It is possible to earn a higher return than the risk-free rate but only by taking a risk; and people may underestimate the dangers. Suppose investors decided to put their entire pension pot into equities and to take an income of 5% a year; if the stockmarket fell by 40%, as it did in 2008-09, then half the pension pot would be gone within two years. Nor do equity markets necessarily rebound; the Tokyo stockmarket is still only a third of the peak reached in 1989.

Investors may also underestimate the costs of riskier investing. Annuity rates are net of fees but those who invest in a mutual fund may be subject to expenses and fees of 2% a year. Many people may prefer to invest their nest-egg in a buy-to-let property. But what if they pick a house on a flood plain, or a property where recalcitrant tenants cause substantial damage or refuse to pay rent for a while? Pensioners may then be stuck with an illiquid asset, with high repair bills and uncertain income.

The chart shows how many years a pension pot will last (on plausible rates of return), for various levels of income. Beating annuity rates (currently 6% for a 65-year-old male, or 4% with inflation-linking) is not automatic.

Of course, buying an annuity involves risk as well. The annuity purchase might occur at an unusually unfavourable moment. There is the risk, if the buyer opts for a fixed-rate annuity, that the income might be eroded by rapid inflation. Conversely, if the buyer opts for an inflation-linked annuity and prices rise more slowly than expected, he might end up with a permanently lower standard of living.

Nor can pensioners know what the future demands on their income will be. The most probable pattern is V-shaped; high spending in the early years while they can still travel; a fall in spending as they become more housebound; and then a surge in spending in the final years to pay for nursing-home care. Given that these decisions are so difficult to make, it is sensible to give pensioners some flexibility. But that already existed

No Briton was forced to buy an annuity until the age of 75. The danger now is that too few people will buy one, even with part of their money, although for some it will be the most sensible product.

There is another agenda at work here. One reason why annuities are so unpopular is that they stop pensioners passing on all their capital to their heirs. But pension saving is given a number of tax advantages: contributions can be offset against tax, no tax is paid on the investment returns and a tax-free lump sum can be taken at retirement. Even though the eventual pension income is subject to tax, this is often at a lower marginal rate than the pensioner paid while in employment.

Richer employees tend to have bigger pensions; in Britain, higher-rate taxpayers get half the benefit from pension tax breaks (the total cost is £35 billion, or $58 billion, a year). Allowing the better-off to pass their capital to their heirs hardly seems a fiscal priority in straitened times.

Will Russia Sanctions Push Europe Back into Recession?

Mohamed A. El-Erian
Chief Economic Advisor, Allianz

Posted: 03/27/2014 11:00 am EDT Updated: 03/27/2014 11:00 am EDT

BRUSSELS -- A common refrain in Europe and the United States these days is that sanctions are a "means to an end" -- namely, use economic and financial pressures to contain and, even reverse Russia's annexation of Crimea. There is a considerable challenge, however. By potentially also pushing Western Europe back into recession, stepped-up sanctions could also be an end in themselves. All of which makes the decision-making process more complex and uncertain at an important geopolitical time.

Western leaders are, as U.S. President Barack Obama said in Brussels yesterday, united in their determination to use sanctions to isolate Russia and impose costs for its annexation of Crimea. And as Jose Manuel Barroso, the president of the European Commission added at his joint appearance with President Obama yesterday, Russia must face the consequences for "unacceptable" actions and behavior.

Western leaders have also warned that any additional territorial incursions by Russia would trigger "deeper" economic and financial sanctions.

This all makes sense. American and western European leaders are loathe to allow Russia to redefine the map of Eastern Europe, especially unilaterally. But they are not in position to use military force to counter what constitutes, as pointed out by the Financial Times last week, "the first annexation of another European country's territory since the Second World War."

Leaders are also right to postulate that deeper sanctions can have quite an economic and financial impact on Russia. Depending on how far they wish to go, they can disrupt cross-border trade, payments and settlements -- all of which would lower living standards in Russia by pushing the economy into recession, fueling inflation, hiking borrowing costs and limiting access to credit.

Already the Russian economy is under some pressure, though due less to the sanctions already imposed by the West and more to the private sector's own endogenous behavior. Specifically, as acknowledged this morning by the economy minister, the country is experiencing an "investment pause," a growth slowdown and large capital outflows "nearing" $100 billion.

Yet Western European support for imposing deeper sanctions is far from universal or unambiguously enthusiastic. Why? Because of the potential for notable collateral damage.

Around 40 percent of Russia's trade is with Western Europe. Even if Russia fails to retaliate by itself imposing counter-sanctions -- an unrealistic assumption -- its weaker economy would quickly translate into lower sales by Western European companies to the world's eighth largest economy, as well as less certain input supplies from there.

Under the more likely assumption of Russian sanction retaliation, Western Europe could face a material threat of disruptions in important energy supplies. The region as a whole cannot reorient quickly its energy networks and dependence; and certainly cannot do so without considerable cost. And some countries are very heavily exposed indeed.

Yes, deeper sanctions would hurt Russia. . . but likely at a considerable cost for Western Europe, too. Indeed, under most scenarios, a back-and-forth escalation in sanctions would push both Eastern and Western Europe into recession.

Realizing this, Russia is comfortable playing the brinkmanship game despite the West's stepped-up threats. For their part, Western leaders cannot ease pressures on Russia, particularly given what has already occurred and the additional massing of troops on Ukraine's eastern and southern borders.

All this speaks to two competing realities. On the one hand, it is the economic self-interest of both Russia and Western Europe to allow proper diplomacy to avoid the escalation of a situation reminiscent of classic Cold War confrontations. On the other hand, there seems to be no immediate practical way of decisively diffusing this modern day Cold War crisis, let alone resolve it durably.


How Putin May Save The Euro Zone

The monetary union now seems more attractive to smaller countries with weak economies.

By Austan Goolsbee

March 27, 2014 7:13 p.m. ET

There is no aroma of chocolate outside the Roshen Confectionery factory in Lipetsk, Russia, today. The Ukrainian candy maker's machines remain idle, toasting no hazelnuts, wrapping no bars. Russian authorities seized the factory last Wednesday after freezing Roshen's Russian accounts.

The company is owned by pro-Western Ukrainian businessman-turned presidential candidate, Petro Poroshenko. This confectionery expropriation surprised no one given the stench of brutality coming from Moscow's invasion of Crimea and its asset seizures there.

By invading Ukraine, Russia's Vladimir Putin seemed to think he could reverse a trend toward Westernization by taking advantage of the European Union's extended period of distraction due to repeated economic crises. Indeed, the euro zone has been involved in a struggle to protect the euro's very existence. The irony is that Russia's actions in Ukraine may have, single-handedly, solved one of the EU's most fundamental economic problems: how to keep weak economies from bailing on the euro zone together.

Public skeptics of the euro zone—and I've been onequestion its durability because of its propensity to destroy itself from within. Locking countries into a monetary union at the wrong exchange rate leaves slow-growing members in a toxic stew of uncompetitiveness and stagnation from which it takes years to escape. The fundamental weakness of the euro zone is that it relies on hard-hit economies—such as Greece and Spain—to endure austerity packages for years to try to raise productivity and cut labor costs enough to make the fixed exchange rate within Europe sustainable. The skeptics predict that eventually these smaller, weaker economies will just give upunless Germany, with its booming exports, subsidizes them over the long term, a prospect the Germans vehemently oppose.
Ikon Images/Corbis

But then the Russians invaded Ukraine. Suddenly, tolerating some years of austerity in order to be part of the euro zone doesn't seem so bad.

Russia's moves are particularly menacing to the many recent additions to the European Union that did time behind the Iron Curtain, such as Bulgaria, Lithuania, Poland, Latvia, Hungary, Romania, and the Czech Republic. These very same countries are next in line to join the euro zone, but they have resisted the required tough conditions such as meeting inflation, deficit, debt and interest-rate targets.

The political will of these countries to actually bite the necessary bullets to join the euro zone had been nonexistentkilled by the euro zone crises of the last several years. Yet following Russia's invasion of Ukraine, they're back. Poland, after years of delaying conversion to the euro, now says it's seriously considering it.

For European economic integration to succeed, the countries with the weakest economies must be willing to endure pain in order to remain in or join the euro zone. Of the 15 countries in the EU with unemployment rates above 9% in the latest Eurostat statistics, almost half share a border with Russia or Ukraine. Of the 13 countries with unemployment below 9%, only one does (Romania).

The Russians seem to have found the one thing the EU has been searching for all along: a lasting way to convince peripheral economies to endure the sacrifices needed to be part of the euro zone. All it took was a reminder of how bad things can get for countries on their own.

Contrast the news on the banking systems as an example. Last week, Europeans announced a deal on a comprehensive banking plan that will give the European Central Bank resolution authority over all banks in the euro zone. Local authorities will surrender some national autonomy in a crisis and that may be unpopular

Alternatively, the Russians announced that Ukrainian banks will be treated as foreign in Crimea and held to Russian laws. The currency will convert to the ruble, and no one in Ukraine knows for sure whether their assets are safe. Bank runs were widespread in the days before the invasion.

After snuffing out the Roshen factory in Lipetsk, Russians will not be able to buy Ukrainian chocolate. Those in other nations still can, though, and Roshen's product catalogue is still online. The first product listed is the Roshen Bitter 67% Cocoa, described as a chocolate "with a balanced sweet and bitter taste." That may not sound as appealing as a fine chocolate from Belgium, but any European would take it over an old Soviet-style Soya Bar.

Mr. Goolsbee, a professor of economics at the University of Chicago's Booth School of Business and strategic partner at 32 Advisors, was chairman of President Obama's Council of Economic Advisers from 2010-11.