Europe overtakes US growth

A James Alexander post

It’s taken a while but the evidence is now in. Euro Area NGDP growth has overtaken US NGDP growth. Congratulations to the ECB, commiserations to the Fed. Go Europe!

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Sadly, it is not quite so simple. While the Fed has much to atone for letting NGDP drift so far off trend, the ECB has much more below trend growth to make up as the growth “gap” since the Great Recession makes very clear.

For those who prefer “Real” GDP, i.e. a real number GDP deflated by inflation, then we can also see a similar pattern of Europe overtaking the US.

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The main reason for this Euro Area relative resurgence is that monetary policy remains on a tightening bias in the US despite these terrible trends in Nominal and Real GDP, while the ECB is still very much in easing mode. The trends are equally visible in Base Money growth: 6% down YoY in the US, 30-40% up in the Euro Area.

The regional drivers of Euro Area growth are the big four countries who make up 75% of Euro Area GDP, while BeNeLux makes up a further 10%. Their report cards show:

  • Germany (29%) – NGDP slowed to 3.2% YoY in 2Q 2016 from a 3.6% trend over the last five quarters. It seems to have been driven by a fall in the deflator rather than RGDP growth which was stable at 1.7% YoY.
  • France (21%) – still growing at over 2% YoY NGDP doesn’t sound exciting but is very good for that country which has a terribly sluggish nominal economy hidebound by labor regulations and other restrictions. QoQ growth was 0%, which wasn’t too bad given the country had terror attacks and a major football championship keeping people away from the shops. Equally, keeping large parts of the labor force out of the economy as evidenced by its very low Labor Force Participation and Employment/Population ratios helps France´s productivity statistics but doesn’t make the country happy or grow very fast.
  • Italy (15%) – Despite the long-drawn out saga of the low nominal growth-inspired banking crisis, NGDP growth in Italy is above 2% for a second quarter running, helping keep RGDP positive YoY. ECB monetary policy is set for the average grower inside the Euro Area and Italy is very definitely average.
  • Spain (10%) – NGDP picked up after a 1Q2016 dip but did not regain the 4% recorded in 2H 2016. Still, it is very welcome given the political chaos engendered by not having a government and as the country has much catch up to do in terms of lost NGDP growth during the double dip recession.

Even writing these mini-report cards on various regions within the Euro Area, one feels very conscious that one is approaching the monetary area the wrong way. It is, or should be, seen as one bloc but the national politics keeps interfering. It mirrors the tension between the permanent Federal Reserve governors and the regional Fed presidents on the FOMC. The US is far more of a single market than the Euro Area but can still see tensions, especially when the central governors are two seats short due to nomination blocs by Congress on Presidential appointees.

Perhaps the sheer diversity of ECB council members strengthens the central officers in a way Janet Yellen can only dream. Who knows? But what is clear is that the ECB is on the right path at the moment while the Fed is not.

The “Monetary Policy Normalization” Syndrome

It has been the force behind US monetary policy for at least the past two years. It can be captured by the behavior of the 1-year ahead expected FF rate, which coincides with the intensification of the “rate rise talk”.

The chart below is a representative example, showing how policy started tightening long before the December/15 rate increase.

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The same is true if you chart inflation expectations, industrial production growth, stock market returns or oil prices alongside the FF future rate.

The “summary statistic” for the policy tightening stance is given by the declining behavior of NGDP (and RGDP) growth since mid-14.

Mp Normalization_2

The fact is that the Fed has “abandoned” the inflation target, or is really content with the low inflation that has materialized in large measure as a consequence of the effective policy tightening.

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Not to be ‘blindsided’, some in the Eurozone have also begun to appeal for monetary policy normalization. An example is given by the recent CEPS study which argues for adopting the GDP deflator as the target, minimizing the worries about deflation captured by the CPI, concluding:

“It is time for a normalization of global monetary policy.”

Mp Normalization_4

No wander the “recession talk” has been on the rise!

Germany vs the Euro 18

A James Alexander post

Almost alone among economic commentators we do actually look at Nominal GDP data as it is released. Full Euro Area NGDP data for third quarter 2015 was released this week alongside the 2nd estimate of Real GDP.

We have already posted here and here on the good news as three of the “big 4” Euro Area countries, making up 75% of the Euro Area economy, had seen accelerating NGDP. The not so good news is that the little countries saw less acceleration; in fact, it looks as though they saw slower growth. It is a bit hard to be exactly precise as the Irish GDP data, both nominal and real does not appear to conform to Eurostat norms. Ireland appears to have been growing NGDP at between 5% and 10% for a couple of years now.

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The result is that Euro Area NGDP, according to the first estimate for this figure, is still picking up but 3Q in total showed growth flattening. It is still below the average growth rate for the last twenty years, a period including the last disastrous seven years. RGDP is growing marginally above this trend.

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The question of trends is important. If we took the trend from 1996 to 2007 then the current Euro Area NGDP and RGDP growth rates looks awful. What should be unquestionable is the dangers of too low NGDP growth, the only unanimous conclusion of fifty years of macroeconomics. Low or negative NGDP growth causes unemployment and welfare loss – as we are seeing now occurring in Switzerland and have seen in many monetary areas since 2007.

What is too low NGDP growth? Perhaps around 2% given long-run productivity growth of over 2%. Economies work best when they have decent flexibility to allow relatively declining economic sectors the ability to decline gently via declining real returns. And economies work very poorly when there is there is an ever-present threat of negative NGDP growth. It is very hard to see what is wrong with at least a 4% NGDP level target. Prosperity must be a more important goal than inflation.

Have we spotted the reason for stiffening German opposition to more QE?

Another way of understanding the dynamics of the Euro Area and its monetary policy is to look at the performance of Germany, 29% of total GDP, and the most nationalistic and selfish country within the Area when it comes to monetary policy. We have seen time and again that what Germany considers right for itself it considers right for the entire Area. Maybe they are right not to care as they are now nearly 30% of the total. But here we see the essence of the current problem: narrow and often wrong-headed national interest. The Centre for European Reform has proposed an interesting reform of ECB governance to deal with just this issue via a removal of national central bank influence on the board.

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German NGDP is growing above trend again, as is its RGDP. Twice Germany was growing so fast it authorised and encouraged the “inflation-nutter” Trichet to his satisfy his mania and crash the Euro Area economy. There are clear signs the Germans are ratcheting up this pressure again.

Fortunately, Draghi is no inflation-nutter. However, he is still trapping himself with the insanely restrictive “close to, but below, 2%” non-flexible inflation target or ceiling. One that only huge amounts of QE can even partially offset.

The natural, normal, “good Europeans”, thing for Germany to do would be to enjoy faster nominal growth than other Euro member states and gradually see itself become less competitive and gradually fall back to relatively less strong growth for a while. Surely, this relative decline would be more in Germany’s longer-run self-interest, rather than crashing the Euro Area economy as a whole again, and probably growing more slowly than it would have done otherwise.