Europe will pay the price for Greece

The rest of the EU should take no pleasure in Tsipras’s discomfort

by: Philip Stephens

A protester waves a Greek flag at the entrance of the parliament building during a rally calling on the government to clinch a deal with its international creditors and secure Greece's future in the Eurozone, in Athens, Greece, in this June 22, 2015 file photo. To match Special Report EUROZONE-GREECE/NEGOTIATIONS REUTERS/Yannis Behrakis/Files

The organising fact of modern policy making is that the urgent tends to obscure the important.
The urgent in this case is the cliffhanger over whether Greece stays in the euro. The important is the uncertain future of the single currency and a threatened unravelling of the postwar project of European integration.

German chancellor Angela Merkel has been carrying Europe on her shoulders. For all his efforts to save Greece from itself, François Hollande, French president, has been diminished by his country’s weak economy. David Cameron, planning a vote on Britain’s EU membership, is not on the field.

The prime minister instead warns holidaymakers to take lots of euros when setting off for Greek islands.

Without a cohesive Europe, Germany is lost. Former chancellor Helmut Kohl understood this when the Berlin Wall came down. The euro was the Franco-German bargain that would make a united

As Ms Merkel treks between Berlin and Brussels, the strain is beginning to show. Her trick when the euro crisis broke was to persuade voters at home that it was worth paying to save the euro while cajoling weak eurozone states into austerity and reform programmes. Solidarity was traded for responsibility. Governments in Ireland, Spain and Portugal would say it has worked.
With Greece, Ms Merkel has fallen off the wire.

Whose fault? There is more than enough blame to go around. As Sigmar Gabriel, the German Social Democratic party leader has observed, Greece should never have been permitted to join the euro. With hindsight it was a mistake also to rule out in 2012 any possibility of sovereign default within the eurozone — though it is easier to make that case now than it was in the turmoil of those times. Subsequent bailouts left Greece with too much debt. Politicians in Athens made promises they never intended to keep.

The Syriza administration of Alexis Tsipras has been the worst of the lot — fuelled by a ruinous concoction of Marxist ideology, an abiding narrative of victimhood and breathtaking incompetence.

There was a deal to be done with creditors. A more mature leader could have sought debt relief in return for fiscal restraint and a drive to stamp out the corruption and clientelism that disfigures Greek democracy. Instead, a modestly improving economic outlook has been replaced by the threat of financial collapse.
The rest of Europe should take no pleasure in his discomfort. Righteous anger is not a substitute for intelligent policy. With Greece on the threshold of euro exit, politicians elsewhere have noted the calm in the markets. Surely this is proof positive that the eurozone’s firewalls against contagion will hold? I would not be quite so sanguine. Shocks are often, well, shocking even when they have been widely predicted.
In any event, the big risk is of political contagion. Politics saved the euro between when economists everywhere predicted its imminent demise. Such professional gloomsters underestimated the willingness of Germany to bend and, Greece aside, the brutal determination of debtor nations to stay in the euro. Now it is politics that could now bring the project crashing down.

The guiding emotion behind Europe’s present discontents is a pervasive sense of powerlessness. The perception that they had been robbed of all say explains the choice of Greek voters in last weekend’s referendum. Voting No collided with the wish of most Greeks to keep the euro, but, as an act of desperation and defiance, it spoke to the frustrations of citizens across the continent.

This is the mood that mainstream political leaders should fear. It has disinterred old nationalisms and served as the recruiting sergeant for the parties of the extremes now challenging Europe’s postwar centrist order. Marine Le Pen’s National Front in France, Beppe Grillo’s Five Star Movement in Italy, Podemos in Spain and Pegida in Germany — all peddle a populism that feeds off the sense that ordinary citizens have become helpless bystanders in a world run for the benefit of the elites.

Europe is assailed from all sides — by the revanchism of Russian president Vladimir Putin to the east, by the rise of violent Islamist extremism in the Middle East and by uncontrolled migration through the Maghreb countries on the other side of the Mediterranean. Stir in a few years of austerity and a rising mistrust of globalisation and it is not hard to explain rising nationalism.

The EU cannot be blamed for the insecurities of globalisation, for Mr Putin’s aggression nor for confessional wars in the Middle East. Yet the genius of the populists has been to channel public anger towards Brussels and its half-finished monetary union. European leaders have yet to offer a convincing riposte. They seem almost embarrassed to say that in a world where power is fast slipping away from the west, they are better off sticking together.

Greece is sui generis and, by and large, the author of its own predicament. Yet it remains a vital piece in the geopolitical stability of the continent. And whatever the central bankers and finance ministers say, a euro without Greece would be a much weakened enterprise — closer to a fixed exchange rate regime than a monetary union. Of course, holding on to Greece would be costly. Losing it would be seriously expensive.

IMF Executive Board Concludes Article IV Consultation with United States

Press Release No. 15/322

July 7, 2015

On July 6, 2015, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the United States.1

The U.S. economy’s momentum in the first quarter was sapped by unfavorable weather, a sharp contraction in oil sector investment, and the West Coast port strike. But the underpinnings for a continued expansion remain in place. A solid labor market, accommodative financial conditions, and cheaper oil should support a more dynamic path for the remainder of the year. Despite this, the weaker outturn in the first few months of this year will unavoidably pull down 2015 growth, which is now projected at 2.5 percent. Stronger growth over the next few years is expected to return output to potential before it begins steadily declining to 2 percent over the medium term.

Inflation pressures remain muted. In May headline and core personal consumption expenditure (PCE) inflation declined to 0.2 and 1.2 percent year on year, respectively. Long-term unemployment and high levels of part-time work both point to remaining employment slack, and wage indicators on the whole have shown only tepid growth. When combined with the dollar appreciation and cheaper energy costs, inflation is expected to rise slowly staring later in the year, reaching the Federal Reserve’s 2 percent medium-term objective by mid 2017.

An important risk to growth is a further U.S. dollar appreciation. The real appreciation of the currency has been rapid, reflecting cyclical growth divergences, different trajectories for monetary policies among the systemically important economies, and a portfolio shift toward U.S. dollar assets. Lower oil prices and increasing energy independence have contained the U.S. current account deficit, despite the cyclical growth divergence with respect to its main trading partners and the rise in the U.S. dollar. Nevertheless, over the medium term, at current levels of the real exchange rate, the current account deficit is forecast to widen toward 3.5 percent of GDP.

Despite important policy uncertainties, the near term fiscal outlook has improved, and the federal government deficit is likely to move modestly lower in the current fiscal year. Following a temporary improvement, the federal deficit and debt-to-GDP ratios are, however, expected to begin rising again over the medium term as aging-related pressures assert themselves and interest rates normalize. In the near-term, the potential for disruption from either a government shutdown or a stand-off linked to the federal debt ceiling represent important (and avoidable) downside risks to growth and job creation that could move to the forefront, once again, later in 2015.

Much has been done over the past several years to strengthen the U.S. financial system. However, search for yield during the prolonged period of low interest rates, rapid growth in assets in the nonbank sector, and signs of stretched valuations across a range of asset markets point to emerging pockets of vulnerabilities. The more serious risks are likely to be linked to: (1) the migration of intermediation to the nonbanks; (2) the potential for insufficient liquidity in a range of fixed income markets that could lead to abrupt moves in market pricing; and (3) life-insurance companies that have taken on greater market risk. But several factors mitigate these downsides. In particular, the U.S. banking system has strengthened its capital position (Tier 1 capital as a ratio of risk-weighted assets is at about 13 percent) and appears resilient to a range of extreme market and economic shocks. In addition, overall leverage does not appear excessive, household and corporate balance sheets look generally healthy, and credit growth has been modest.

The consultation focused on the prospects for higher policy rates and the outlook for, and policy response to financial stability risks, integrating the findings of the latest IMF Financial Sector Assessment Program for the U.S.

Executive Board Assessment2

Executive Directors agreed with the thrust of the staff appraisal. They noted that the economic recovery continues to be underpinned by strong fundamentals, despite a temporary setback, while risks remain broadly balanced. Directors observed that considerable uncertainties, both domestic and external, weigh on the U.S. economy, with potential repercussions for the global economy and financial markets elsewhere. These include the timing and pace of interest rate increases, prospects for the dollar, and risks of weaker global growth. Directors stressed that managing these challenges, as well as addressing longstanding issues of public finances and structural weaknesses, are important policy priorities in the period ahead.

Directors agreed that decisions on interest rate increases should remain data-dependent, considering a broad range of indicators and carefully weighing the trade-offs involved. Specifically, they saw merit in awaiting clear signs of wage and price inflation, and sufficiently strong economic growth before initiating an interest rate increase. Noting the importance of the entire path of future policy rate changes, including in terms of the implications for outward spillovers and for financial markets, Directors were reassured by the Federal Reserve’s intention to follow a gradual pace of normalization. They welcomed the Federal Reserve’s efforts, and commitment to continue, to communicate its policy intentions clearly and effectively. Directors acknowledged that financial stability risks could arise from a protracted period of low interest rates. In this regard, they underscored the importance of strong regulatory, supervisory, and macroprudential frameworks to mitigate these risks.

Directors commended the authorities for the progress in reinforcing the architecture for financial sector oversight. They concurred with the main findings and recommendations of the Financial Sector Assessment Program assessment. Directors highlighted the need to complete the regulatory reforms under the Dodd-Frank Act and to address emerging pockets of vulnerability in the nonbank financial sector. They encouraged continued efforts to monitor and manage risks in the insurance sector, close data gaps, and improve the effectiveness of the Financial Stability Oversight Council while simplifying the broader institutional structure over time. Directors looked forward to further progress in enhancing cross-border cooperation among national regulators, and the framework for the resolution of cross-jurisdiction financial institutions.

Directors noted that there remain a range of challenges linked to fiscal health, lackluster business investment and productivity growth, and growing inequality. They agreed that reforms to the tax, pension, and health care systems will help create space for supporting near-term growth, including through infrastructure investment. Directors reiterated the need for a credible medium-term fiscal strategy that would anchor ongoing consolidation efforts, underpin debt sustainability, and reduce fiscal uncertainties. They called for renewed efforts to implement structural reforms to boost productivity and labor force participation, tackle poverty, address remaining weaknesses in the housing market, and advance the multilateral trade agenda.

It is expected that the next Article IV consultation with the United States will be held on the standard 12-month cycle.

United States: Selected Economic Indicators 1/
(percentage change from previous period, unless otherwise indicated)
 National production and income        
 Real GDP2. 
 Net exports 2/-0.2-0.7-0.5-0.4-0.4-0.3-0.3 
 Total domestic demand2. 
 Final domestic demand2. 
 Private final consumption2. 
 Public consumption expenditure0. 
 Gross fixed domestic investment3. 
 Private fixed investment5. 
 Equipment and software6. 
 Intellectual property products3. 
 Nonresidential structures8.2- 
 Residential structures1.66.510. 
 Public fixed investment- 
 Change in private inventories 2/ 
 Nominal GDP3. 
 Personal saving rate (% of disposable income) 
 Private investment rate (% of GDP)16.416.817.317.718.118.218.4 
 Unemployment and potential output        
 Unemployment rate6. 
 Potential GDP1. 
 Output gap (% of potential GDP)-2.0-1.6-0.7- 
 CPI inflation (q4/q4) 
 Core CPI Inflation (q4/q4) 
 PCE Inflation (q4/q4) 
 Core PCE Inflation (q4/q4) 
 GDP deflator1. 
 Government finances        
 Federal government(budget, fiscal years) 
 Federal balance (% of GDP)-3.2-2.8-3.0-2.6-2.5-2.9-3.2 
 Debt held by the public (% of GDP)74.074.975.375.074.574.474.8 
 General government(GFSM 2001, calendar years) 
 Net lending (% of GDP)-4.9-4.4-4.2-3.8-3.7-4.0-4.2 
 Primary structural balance (% of potential GDP)-2.3-1.8-1.8-1.5-1.4-1.6-1.6 
 Gross debt (% of GDP)106.4107.3107.9107.9107.6107.6108.2 
 Interest rates (percent)        
 Fed funds rate0. 
 Three-month Treasury bill rate0. 
 Ten-year government bond rate2. 
 Balance of payments        
 Current account balance (% of GDP)-2.4-2.7-2.9-3.1-3.2-3.3-3.4 
 Merchandise trade balance (% of GDP)-4.2-4.1-4.2-4.4-4.5-4.6-4.8 
 Export volume (NIPA basis, goods) 
 Import volume (NIPA basis, goods) 
 Net international investment position (% of GDP)-39.7-41.3-42.9-45.8-49.1-53.0-59.0 
 Saving and investment (% of GDP)        
 Gross national saving18.117.817.617.818.018.018.0 
 General government-1.6-1.5-1.3-1.0-1.0-1.3-1.6 
 Gross domestic investment19.820.120.520.921.121.221.4 
 Sources: Haver Analytics; and IMF staff estimates
 1/ Components may not sum to totals due to rounding
2/ Contribution to real GDP growth, percentage points

1 Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board.

2 At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities. An explanation of any qualifiers used in summings up can be found here:


Contributing Op-Ed Writer

It’s Time for Greece to Leave the Euro

HAMBURG, Germany — DOES democracy trump debt? Of course not, not even in Europe. No bank clerk here would be impressed if a family told her that they had voted to have the terms of their housing loan renegotiated — that’s not how loans, either personal or international, work. Yet leaders are gathering for a special summit meeting in Brussels on Tuesday because the Greeks have done exactly that: voted against the conditions the eurozone demands for a third bailout program for their country.
Of course, negotiations are a good in themselves, especially in Europe. But even in Brussels, there comes a time when losing your nerve is a rational choice. I don’t say it lightly, but I believe this point is here now. Europe has more to lose from a Greece that remains part of the eurozone than from a controlled exit, in which Greece softly steps out of the single currency.
There was a point when things looked promising. After the European Union and the International Monetary Fund stepped in with their first two bailout programs, Greece made considerable progress on closing its deficits. Between 2010 and 2014 it implemented spending cuts virtually unprecedented in a developed country. Those cuts meant hardship to many in Greece. But they began to pay off: By the end of 2014, Greece was spending less than it was collecting in taxes (if you leave aside interest payments).
But the cuts to social-welfare programs and public-employee salaries also drove up support for the radical left Syriza government, which took over earlier this year. It stopped the reforms and blurrily demanded other, bigger changes, including a “new deal” for all of Europe — whatever this is supposed to mean.
It may well be that most of the 61 percent of the Greeks who voted “no” on Sunday to the latest demands for cuts by the eurozone countries merely want changes in the details of a new bailout deal with Brussels. Sure, such demands could be up for debate. Yet it has become hard for those seated across the negotiating table from Prime Minister Alexis Tsipras to believe he is interested in a pragmatic solution. The radicals who back him in Parliament want changes to the currency system and Europe’s economic model itself. And while he may yet have a trick up his sleeve, Mr. Tsipras appears intent on using the outcome of Sunday’s referendum to fuel his crusade against the chimera of a “neoliberal” Europe.
True, Mr. Tsipras sacked his controversial finance minister, Yanis Varoufakis. But one ideologue fewer doesn’t make this government less ideological. As childish as it sounds, Mr. Tsipras and his fellow fighters are still raging against the triviality that you can spend only what you earn. Leaving aside Syriza’s Nazi-Merkel comparisons and accusations of “terrorist” behavior by creditors, over the past five months Europe has heard way too much from his government about the impossibility of further cuts and way too little about possible sources of new income.
Still, patience with Greece in her party, the conservative Christian Democrats, is waning rapidly, as it is in Germany’s staunchest economic allies, the Netherlands, Finland and the Baltic States. To many Northern Europeans, both the Greek government and the Greek people have finally demonstrated that, according to them, no given rule is ever fixed. This mentality is not just alien to the rather Protestant northerners. It also holds a danger for Europe’s political fabric.
Right now many observers are fixated on the risk of Greece’s exiting the euro. But the risk of keeping it in at all costs is even higher. Consider this scenario.
Unemployment in Italy, Portugal and Spain remains high, and anti-European Union populists are on the rise in all three. The conclusion that people there could draw from a third bailout program for Greece would almost certainly be that voting for radical parties and obstructive behavior are eventually rewarded. You just have to be cocky enough. And if that happened — if, say, a Syriza clone came to power in Spain, or if the leadership in those countries expressed a strong sympathy for Greece’s position — the counterreaction in the creditor countries could be harsh, even hostile. Europe could end up with a calamitous north-south divide along camps known from the Cold War: the “socialists” there, the “capitalists” here.
Neither the eurozone nor Europe is best served by holding on to Greece. Instead, the European Union needs to come up with a smooth way out of its dilemma, namely an orderly exit by Greece from the euro.
This solution will be expensive, too — among other things, the European Union will have to make sure that Greece’s post-euro currency isn’t so cheap that Greeks can’t afford vital imports, like oil and medicine. Yes, Greece still must be rescued. But no, it need not be rescued within the eurozone.

July 8, 2015, 3:40 PM ET

Higher Rates Wouldn’t Tame Bubbles Even if Central Banks Tried, IMF Paper Says

By Pedro Nicolaci da Costa

Federal Reserve officials shouldn’t use monetary policy to combat asset bubbles, says a new IMF working paper.

Economists at the International Monetary Fund have found a new reason for central bank officials to avoid using interest rates to dampen asset bubbles and market risk: it probably wouldn’t work.

That’s the finding of a new working paper that identifies different patterns in lending between banks and nonbanks. The gap means raising borrowing costs to curb market excesses might simply push risks into less regulated financial firms sometimes referred to as the “shadow” banking system.

“The different credit and business cycles magnify the tradeoffs of using interest rates to contain financial stability risks,” write IMF staffers Alexander Herman, Deniz Igan and Juan Solé.  “From a policy perspective, our analysis is more supportive of placing greater emphasis on macroprudential measures than on using interest rates to address risks in the financial sector.”

By “macroprudential measures,” they were referring to regulatory and supervisory tools such as credit restrictions on specific industries or limits on loan-to-value ratios.

The research adds to the debate over whether central banks should consider raising interest rates to prick apparent financial asset bubbles while they are forming, to forestall the damage to the financial system that could occur if they burst on their own.

Before the financial crisis, the standard view at many central banks including the Fed was that, because asset bubbles are too hard to spot ahead of time, policy makers shouldn’t raise rates to restrain them. Instead, officials should wait until after they burst, and if necessary cut interest rates to help the economy recover afterward. This was sometimes referred to as “mopping up.”

The heavy toll of the 2008 financial crisis that followed the housing bubble, estimated at several trillion dollars in lost economic output and millions of jobs eliminated, led many policy makers to question that view. The mess was simply too great to mop up.

Many Fed officials now say interest rate increases should only be used as a second line of defense against asset bubbles because they could unnecessarily curtail economic recovery. San Francisco Fed President John Williams has argued against ever using rate increases to lessen financial stability risks, saying the cost would be far too high.

The IMF economists largely agree: “During output downturns, supervisory scrutiny should be intensified to counter the continued accumulation of financial risks.”

Regulators must do this by focusing on long-term risk trends, not simply short-run market fluctuations, the authors say.

“By adopting a short-term view and focusing on recent incremental changes in risk metrics, financial stability practitioners may miss the secular accumulation of key vulnerabilities,” they write. “The unpleasant analogy, here, is the one of the frog in the boiling pot.”