Why Fed, ECB’s ‘Great Job’ Is Not Moving Global Economy
Excessively tight fiscal policies in the U.S. and in the euro area are depressing economic growth and employment in nearly two-thirds of the industrialized world. These two economic systems also represent about 40 percent of the global economy.
At the same time, one-third of the world economy lives off its trading partners.
There, in the nutshell, is what is holding back demand, output and job creation on the global scale.
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And these are the powerful headwinds the U.S. and euro area monetary policies are working against. A better understanding of these problems gives a very different perspective on the difficult tasks facing the U.S. Federal Reserve and the European Central Bank (ECB).
For it is not the ineffectiveness of the monetary policy we are dealing with. It is the rare combination of a simultaneous impact of hugely restrictive fiscal policies, gravely damaged channels of financial intermediation and crippling trade imbalances in especially depressed segments of the world economy - the euro area - where there is an obvious need for a strong stimulation of domestic demand in countries of that region whose trade surpluses range from 2 percent to nearly 9 percent of gross domestic product (GDP).
Fed and ECB Have Done a Great Job
Extraordinary instruments and techniques of monetary policy used by the Fed have been an appropriate response to an imploding financial system and the ensuing recession of exceptional severity. The sequels of the crisis are still there: At the end of the last reserve reporting period in mid-April, distress borrowing at the Fed stood at twice the "normal" levels observed during the time preceding the onset of the 2008 crisis.
All that is reflected in the relative weakness of the U.S. banks' lending activity. Their consumer loans in the year to February increased by about 3 percent, while non-bank lending to households during the same period soared by 9 percent, showing that banks' sluggish consumer lending is not a question of a weak loan demand.
And neither is it a question of the lack of loanable funds. Banks are currently sitting on $1.7 trillion of excess reserves, a 13 percent increase from the year before.
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The Fed's efforts to help the convalescing financial system to restore the traditional channels of financial intermediation have made substantial progress. Easy credit terms are getting through to the real economy, and there is no doubt that the monetary stimulus is partly offsetting the depressive impact of spending cuts and tax hikes.
Much more serious problems are facing the ECB, because its credit expansion is not providing any meaningful relief to the euro area businesses and households.
And the currently discussed relaxation of fiscal policies in the European monetary union will only mean a little more time to meet sharply lower deficit targets for France, Spain and Portugal (35 percent of the euro area), with no concession on their obligation to step up structural reforms whose short-term impact will lead to rising unemployment.
The best the ECB can do in this gloomy environment is to provide some crisis backstops. Its monetary policy has no traction because the euro area's weak, undercapitalized and, in many cases, utterly dysfunctional financial system is incapable of funding businesses and households. That is clearly shown by the ECB's data. Bank loans to the private sector in the first two months of this year were 0.9 percent below their depressed year-earlier levels.
It is, therefore, a good bet that the triad of fiscal austerity, short-term growth-stifling structural reforms and seemingly intractable problems of a weak banking system will soon lead to the downward revision of the ECB's long-standing growth forecast for the euro area. I expect them to say that the economy's green shoots they were looking for are unlikely to begin sprouting later this year.
Less Budget Cuts and Less Trade Surpluses
The Fed is facing a different picture. They are keeping an eye on a modestly growing economy where inflation and asset bubbles could complicate exit strategy from an extraordinarily loose policy stance. But the Fed also knows that the apparent inability of the Congress and the White House to agree on taxes and spending will leave the U.S. fiscal policy on an arbitrary path of substantial restraint. And that, of course, is a powerful drag on the economy the Fed is trying to offset before it begins withdrawing its monetary stimulus.
Formally, the euro area fiscal policy is not on such an automatic pilot, although the newly established disciplinary procedures of the budget process may look like a twin to American sequestration tentacles. That is obviously an unreasonable and politically disruptive fiscal policy in a situation where the weakening banking system cannot provide an effective transmission of the ECB's attempt to restart the euro area's moribund economy.
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Things are stirring, though. Opposition to indiscriminate fiscal tightening is getting broader and louder. Ever vigilant about its restless body politic, government's sinking approval ratings and a deepening gloom, France is determined to slow down its drive to lower budget deficits as it tries to moderate its ongoing recession and rising job losses. Spain and Portugal are on the same track.
But the cruel irony is that any improvement in demand and output conditions in these three countries will partly leak out and benefit the euro area countries with large trade surpluses because their economies are running on exports rather than domestic demand. Led by Germany, these surplus countries know that, and they are steadfastly refusing to stimulate their domestic demand to help the hard-pressed economies in the European south. So much for the euro area solidarity.
Repeatedly called out to get off its export gravy train, Germany is totally ignoring these appeals, whether they are coming from within the euro area, the International Monetary Fund (IMF) or even from the G-20. In response to such a call from the G-20 in Washington, D.C. last week, Germany's finance minister side stepped the issue and talked about the need for the ECB to start withdrawing its money market liquidity – i.e., whatever remains of a meager life support to economies crushed with 19 million people out of work and 3.6 million of young people unable to find jobs and make a living.
The euro area will remain a serious problem for the world economy as far as the eye can see. Destructive political clashes are looming, and they won't necessarily wait for German elections next September.
But there is no need for political clashes to convince large trade surplus countries in East Asia to keep more of their hard-earned savings home - instead of financing deficits of much richer countries - to improve their infrastructure and public services. That would raise the well-being of their people and set the stage for a steady and sustained growth of their economies.
Before incorrectly blaming the Fed and the ECB for their allegedly ineffective monetary policies, investment strategists would do well to reflect on the depressive impact of an unreasonable haste to balance budgets, and on political leaders' inability to strengthen the financial systems (in the U.S. and in Europe) and to negotiate a better balanced world economy.
Michael Ivanovitch is president of MSI Global, a New York-based economic research company. He also served as a senior economist at the OECD in Paris, international economist at the Federal Reserve Bank of New York and taught economics at Columbia.