Growth resumes in the Eurozone. For the EA, it is 0.4% and for Spain 0.7%. Even Italy is recovering and returning to positive territory. France disappoints. Despite strong measures taken on purchasing power, political uncertainty penalizes activity. It could last
French GDP growth decelerated slightly in the first quarter of 2019 even though the rounded figure stands at 0.3% (non-annualized) as in the previous two quarters. Despite the stimulus measures announced at the end of 2018, growth has not been boosted by the increase in households purchasing power.
Achieving the government target at 1.4% for 2019 on average would require growth of 0.43% in each of the remaining three quarters. It’s ambitious.
The annual change in activity is 1.1% in the first quarter, well below the trend observed since the 2013 recovery at 1.4%.
After the acceleration of 2017, resulting from the very buoyant global environment, the growth of the French economy can not deviate from the figure of its potential growth estimated generally between 1.2 and 1.3%.
For the moment, the measures implemented by the government are not able to go beyond this and this is worrying in a context where the sharp rise in the price of gasoline is a threat to the purchasing power that would penalize consumers’ demand.
Contributions to quarterly GDP growth are easy to remember. Domestic demand contributed 0.3%, inventories increased GDP by 0.3%, while net exports slowed growth with a contribution of -0.3%.
The important point is the slight acceleration of household consumption whose contribution goes from 0 in Q4 2018 to 0.2% in the first quarter. This is barely above the average observed since the recovery (0.15%) while government measures explicitly targeted consumption.
Government spending is growing at a slower pace, and this is the same for investment, whose contribution is decreasing marginally, notably because of the contraction of household investment. On the corporate side, the investment is a little stronger than in the last quarter of 2018 and that’s good news. However, this remains very limited (see the graph in appendix). This is insufficient to instil a solid dynamic into the cycle of the French economy.
The bad surprise comes from foreign trade whose pace is less robust than the monthly figures suggested until February. The contribution is frankly negative even if the contribution of imports is less negative than in Q4 2018. Exports stagnate and penalize growth. The French economy is also penalized by the world trade slowdown.
The accumulation of stocks has driven growth upward. Its pace in the second quarter will depend on the dynamics of demand. If this strengthens stocks will continue to fill. On the other hand, if the demand is lower, because the price of gasoline increases a little too fast, then companies could reduce these stocks which would penalize the profile of the activity.
The French GDP for the first quarter of 2019 will be published Tuesday morning at 0730. After a figure of 0.3% (non annualized figures according to the French tradition) over the last three months of 2018, the consensus is at 0.3%.
My expectation is that 0.3% would rather be the bottom of a range between 0.3 and 0.5%.
During the first three months of the year, there was a clear improvement in industrial production (+ 1.2% carryover for Q1 at the end of February against -0.4% in the last quarter of 2018). There is also a recovery in the pace of the business climate survey. In the last quarter of 2018, this index fell by 2.1 points compared to the previous quarter, whereas it stabilized over the first three months of the year.
It should also be noted that household consumption is slightly positive when it contracted in the last quarter of 2018. Finally, foreign trade could have a neutral impact, with exports (in value) growing a little faster than imports but Given the deficit, the contribution will be close to neutrality.
The big unknown is about business investment. Capital goods orders are shrinking rapidly, suggesting a lower capital expenditure despite the stabilization of business surveys.
Looking at the industrial production and surveys, GDP is expected to pick up slightly in Q1 at 0.4%. If business investment is less dynamic than expected then it will converge to 0.3%. If all goes well (the services sector momentum is improving in the INSEE survey, if the investment is more robust than expected and consumption accelerates in March) then the figure of 0.5% could be reached.
The French President announced several measures during his press conference last Thursday.
There are structural measures such as reducing the number of pupils per primary class to 24. It is an important choice to stop the deterioration observed, for France, in every international rankings on school. This is a first step, a necessary condition for reducing inequalities and improving equality of opportunity.
The other structural measure relates to public service houses. A house should be set up in each administrative district (Post Office, Social Security, Unemployment administration, ..)
The state must re-acquire the territories to make life easier for everyone. It is also a measure of reducing inequalities and it was an initial demand of November’s protesters (yellow vests).
Comments on decentralization have not been sufficiently specified to be a structural measure. .
The objective is to allow a better equilibrium of the French society and the capacity to face a world which changes thanks to the formation, which starts with new measures at the primary level (24 pupils).
There was also a battery of short-term measures on the reduction of the income tax (5 billion as of January 2020 for 15 million French), the renewal of the non-taxed bonus, the re-indexation of small pensions (less than 2000 € ) in 2020 and for every pension in 2021.
These amounts are significant and will take effect from January 2020 as stated by Gerald Darmanin (finance minister) on the reduction of taxes.
We can make three remarks
1 – The government is paving the way for moderate but stable growth for 2019 and 2020. The measures announced last December (mainly higher income for people at the bottom of the income scale) will be a support for growth in 2019. The measures announced last Thursday will take over in 2020.
2 – The government wants to immunize the French economy from external shocks by supporting the internal demand and especially household consumption. The downturn in world trade and uncertainties are all sources of slowdown in activity. By supporting domestic demand, the government allows for a more flexible way to cushion these shocks, thus reducing the volatility of French growth.
The new measures for 2020 are smaller than those announced for 2019 suggesting that the government does not expect a extended crisis. This hypothesis is important for the business investment momentum. A higher expected demand will reflect in higher corporate investment.
What is unfortunate is that this economic response is only carried by France in Europe while the shock is perceived by all (see here)
3 – The question of financing all these measures remains fuzzy. Macron spoke about lower expenditures, elimination of corporate tax loopholes and the necessity to work longer. These three means must finance all the measures but there are absolutely no details on how it will work. It could also be through an larger public deficit but this was not discussed by the president.
It is unfortunate that the “grand débat” has not allowed a deep discussion on public expenditures . The initial stance of the November protesters was that taxes were too high. The reduction of taxes necessarily requires a reduction in spending. The choices to be made are complex, but we could have expected the “grand débat” to make collective choices on this point. This has not been the case and it is a shame because it will have to be done.
The world of politics and politicians wants to get its own back on the central banks. Central banks have been at the very heart of steering the economy since the start of the crisis at the very least, as they have been more present and reacted more swiftly than governments, bar a few exceptions such as coordinated fiscal stimulus moves in 2009.
Yet politicians are now wading in to tackle central banks’ domination at various levels. Firstly, Democrats are championing the MMT – Modern Monetary Theory – approach, suggesting that governments are responsible for managing the economy. Then we have the politicization of the central bank, with Donald Trump’s attempts to appoint members who are not renowned first and foremost as economic experts, or Erdogan taking control of the central bank in Turkey, while in India, Modi changes governor each time the current one no longer meets his requirements.
Politicians now want the pendulum to swing back in their direction as they seek to take back control after letting central banks play a key role in steering the economy. But it may not be that straightforward.
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A recap of central banks’ independence
Central banks have had a considerable grip on economic trends for the past several years. At the start of the 1980s, their role was to cut back inflation, after governments had let it spiral out of control. Paul Volcker went all out on this front, and this shift in the balance of power gained greater ground over time. Theoretical and empirical indications bore out this idea that an independent central bank was required to facilitate and optimize regulation of the economy.
When the euro area was set up, the central bank’s independence became the norm for member countries as well as several other countries.
Having two bodies to steer the economy and reform economic structures – the government and the central bank – was deemed wise. Work on coordination of economic policy has enhanced the way the two work together to make for more efficient running overall.
After the 2008 watershed, central banks’ crisis management moves increased their influence. Implementation of unconventional monetary policy in the US and the UK gave monetary authorities a major advantage, enabling governments to take on debt to address the aftershock of the financial crisis and spread out its effects over the longer term, while also covering this debt via vast purchase programs, or Quantitative Easing. Meanwhile, the development of forward guidance on expected future interest rate trends enabled central banks to steer investors’ expectations over the long term and avoid any potential unwanted rate trends.
In the euro area, the ECB became more independent when Mario Draghi took over at the helm: he made the monetary authority a true lender of last resort, gave the euro greater independence and shifted the central bank’s political balance that had been so troublesome for his predecessor to the detriment of real economic questions. Quantitative Easing and the forward guidance process also helped assert this greater independence.
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Doubts over this independence
Politicians have now seen that reality is running away from them and central banks have too much clout in controlling the economy.
Donald Trump swiftly explained that excessively high interest rates hampered US growth, but Jay Powell, the Chair he had himself appointed, held up under this pressure. The President is now endeavoring to stymie the monetary policy committee by appointing members who do not have the rights skills and experience, such as Stephen Moore and more recently Herman Cain, before he retracted. The White House’s nominations have to be approved by Congress so the game is not over yet, but a potential second term for Trump in 2020 could upturn this balance due to the seats on the board coming up for nomination. This is a huge risk for the Fed’s independence over the years ahead.
Republicans in Congress very recently wanted to set a well-defined framework for the Fed’s actions along the lines of the Taylor rule. This would clearly limit the central bank’s scope to make its own interpretations of the economic situation, with the risk of triggering excessive interest rates movements that could disrupt the pace of the economy in the long term.
In the shorter term, the main doubt over central banks comes from the American Democratic party and its most left-wing potential presidential election candidates.
Bernie Saunders and Alexandria Ocasio-Cortez (AOC) in particular want to give politics precedence over economics again, with politics leading and economics merely managing. They base their approach on Modern Monetary Theory, which suggests that the size of the deficit is not very important if debt is financed in local currency: against this backdrop, the economy is steered and adjusted via changes in spending and tax and no longer by movements on interest rates primarily.
With this approach, growth and inflation would thus be better steered by the government than the central bank. A number of economists are unconvinced by this method, which is a theory in name only: it is also worrying as when governments have taken control over the economy in the past, it has been to the detriment of the central bank and often ended with phases of marked instability. This particularly calls to mind hyperinflation in Germany, although this may seem an excessive viewpoint with evenhanded elected leaders.
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Long-lasting shift
What matters here is not so much the theoretical approach, but rather the potential change it could trigger in the pecking order for the economy’s different managing authorities. If the pyramid of powers were to change, the central bank’s action would then depend on the government’s moves in a radical turnaround compared to the past 40 years. There are several points worth noting.
We will need to keep a close eye on the forthcoming replacement for Draghi and other members of the board at the ECB, as we keep this balance of power in mind, particularly as these changes will take place after the European elections.
However, the central banks have a major advantage: in the past, they have systematically stuck together during crisis periods to curb risks on liquidity. This ability to react and work together outside any political framework helped reduce both the length and the extent of crises. Yet we cannot spontaneously expect any similar behavior from governments in the long term, and coordination displayed at the time of stimulus measures in 2009 only lasted a short length of time, while this was not true of the central banks.
In a recent book, Paul De Grauwe suggested that the economy is like a pendulum swing back and forward between market and state in overall management of the economy. An excessive role for the market led to imbalances, which were corrected by greater government intervention as it took back control, leading to imbalances that were only evened out by accepting a greater role for the market…
This type of pendulum swing looks unlikely, but we must be realistic: politics and politicians have taken back greater power in both China and the US, particularly in China. Meanwhile the populist movement in Europe is primarily a political movement, and it seems unlikely that this trend will end soon and for such times as the middle classes do not derive the full benefits of growth.
This post is available in pdf format My Weekly Column – 23 April 2019
How to read the end of the risk associated with the Brexit of March 29th? Look at the 10-year Bund rate. It dropped into negative territory with the risk of an immediate and brutal shock related to Brexit. With the UK’s exit from the EU postponed, this immediate risk disappears and the rate comes back into positive territory again
Source Bloomberg
