The British parliament is undecided. The vote on the possibility of a no deal is very divided. 321 against a no deal but 278 in favor of a lack of agreement to go out. Almost half of the parliamentarians wants a brutal exit from the EU. The idea, supported by many commentators, that it would be enough to abandon the exit procedure because it is not popular is false. What is interesting is that the parliament was very much in favor of the “remain” just after the referendum. It has evolved a lot. This is why a second referendum is in no way a guarantee of a “good vote”. This is the lesson of last night’s vote (Wednesday).
Next step tonight with the vote on the deadline request. It can not run after the start of the next European semester, otherwise the English will have to vote in the elections for the European Parliament. But from now to the end of June, what can we expect again? And will the Commission and the European governments validate this extension for not much? This possible postponement is reminiscent of Madame du Barry asking the executioner December 8, 1793 “One more time Mr. Executioner”. We know that the outcome was fatal.
The OECD and the ECB have downgraded their 2019 growth projections for the euro area in quick succession, with the OECD now expecting 1% for the year ahead vs. 1.8% previously, and the European Central Bank projecting 1.1% vs. 1.7% in December, putting euro area growth below its potential pace. The main reason for this rapid slowdown of the activity lies in the rapid deceleration of world trade, particularly in its Asian component. The White House policy is a key explanation of this trend change. This external shock profoundly modifies the equilibrium of the euro zone economy.
The OECD believes that the economy in the bloc has now become a source of concern for the world economy as a whole. Beyond the euro area’s actual situation, a slowdown in the zone along with a sharp and swift downgrade to growth projections for 2019 also make for a shock on world growth. The area is a major contributor to world trade momentum, so a drastic slowdown is an additional source of concern for the world economy. It is worrying that the euro area is so large, but yet it is still at the mercy of international events with little capacity to react to them clearly. It was buoyed by strengthening trade in 2017 but was dented by the recent negative shock, and its inability to absorb these tremors is alarming for the world as a whole and not just the European economy.
This situation reflects the fact that the area has
become more and more open to outside influences, while for example the United
States’ exposure to trade with the rest of the world has remained steady over
time. Germany plays a major role in this trend, as shown by the chart, while Italy
and France are similar in terms of how open their economies are to trade with
outside countries (the OECD suggests that Italy has a greater dependence on
world trade than France. This is excessive (see the graph). But this is the
main explanation of the more robust growth in France according to the OECD
The most surprising aspect during
the current downgrades to growth projections is that this swift drop reflects
the dearth of economic policy to cushion the shock.
The policy mix – i.e. the way fiscal policy and monetary policy work together – is restrictive. Financial conditions are admittedly encouraging as a result of the ECB’s accommodation, but fiscal policy has been restrictive for too long and is not propping up economic activity, meaning that the shock from the world economy is in no way cushioned by euro area economic policy.
The chart shows the primary budget
balance (excluding interest payments) adjusted for the economic cycle and
expressed as a % of potential GDP. This figure is an indication of how restrictive
fiscal policy is, and in the euro area the balance is positive, pointing to restrictive
Despite the agreement between the Italian government and the European Commission, the question of the Italian public debt sustainability is not solved. The marginal move from the government (reducing its budget deficit to 2.04% of GDP vs an initial 2.4%) is not sufficient to explain it.
The best explanation is that no one wanted to have the responsibility of a deep European financial crisis linked to the lack of liquidity of the Italian debt market The commission has accepted because the situation was not manageable.
In the short term, investors will be pleased and the spread with the German Bund will narrow. But the main question is not solved. Growth in Italy is too low.
The Italian economy is already in recession (GDP growth was negative in Q3 and companies’ surveys are on the contracting side of the economic activity) this means that the budget deficit will converge to 3%, not 2%
The question on the debt is that interest rates are higher than the GDP nominal growth. Therefore the public debt to GDP has a growing bias(a snowball effect). Italy has had a primary budget surplus for years, it is not the question. For Italy a sustainable path for its public debt must find a way to make the government credible in order to limit the premium on its interest rate and to find a way to boost its growth. Who can imagine that? Be prepared then for the next financial crisis it is coming
The European Commission has just told Italy to revise its 2019 budget plan: the deficit does not look excessive (2.4%), but the figure is deemed to be fragile as growth projections are overly optimistic….and with a government that emerged from a watershed vote, we should expect a certain degree of laxity on spending to boot. The government was not elected to do the same thing as its predecessors, i.e. there is a risk that the budget will spiral out of control and move above the notorious 3% of GDP threshold, which is incompatible with a stabilization in public debt. Italian public debt stands at close to 132% of GDP, well above the standard 60%, and this is not sustainable. Yet does a sustainable trend automatically involve a drastic cut in the public deficit? Maybe not.
There are a number of points worth raising on the budget/Italy/European Commission issue. Continue reading →