Professor Monti and the bubble

Paolo Manasse, Giulio Trigilia, Luca Zavalloni, 19 March 2013, voxeu

Who saved Italy? This column argues that the crisis began with Silvio Berlusconi and ended with Mario Monti. Evidence suggests that restoring a sense of credibility to Italian policymaking was difficult to earn but may be very easy to lose (as the recent run on Italian debt suggests). New and old Italian politicians cannot afford to underestimate the formidable challenge ahead: getting Italy out of this depression without jeopardising its credibility.

The recent Italian elections yielded a hung parliament. Votes were shared almost equally between the centre-left coalition of Bersani, the centre-right coalition of Berlusconi, and the new Five Star Movement of Grillo. Monti’s Civic Choice party appealed to only one in ten voters.

The election results show that Grillo and Berlusconi have been quite successful in depicting Mario Monti as Angela Merkel’s ‘longa manus’ in Italy, and in blaming her austerity measures for the current recession. Unlike financial markets, which hailed Monti for restoring Italy’s ‘credibility’ by fixing the budget, starting an ambitious reform agenda, and for steering the country off the cliff of default, Monti’s opponents claimed that Monti’s supporters (the ‘Mario Italians’) had Draghi, not Monti, to thank for reducing the ‘spread’. After all, it was Draghi’s speech of 26 July 2012 –”We will do whatever it takes … and, believe me, it will be enough” – and the subsequent Outright Monetary Transaction programme in early September 2012 that reassured investors over the impossibility of a Eurozone breakup.

For economists, unlike for politicians, this is clearly an empirical question. We argue that what has happened to interest rates and credit default swap spreads in Italy since July 2011 looks like a short-lived confidence crisis. The evidence suggests that Monti did indeed ‘punch the bubble’ by restoring ‘credibility’.

Eurozone crisis: It ain’t over yet

Paolo Manasse, 17 January 2013, voxeu

All G7 economies are struggling in the post-crisis climate, but US GDP has recovered to pre-crisis levels, while the Eurozone simply hasn’t. This column portrays the global crisis as a transitory shock for the US, but as a quasi-permanent shock for Europe. The policies that are needed get the Eurozone back on track do not seem to be politically feasible. As tension rises with every quarter of stagnation, prospects for the survival of the euro are not only not improving, they are actually getting worse.

Despite apparent calm on the financial markets, no illusions that the storm is ending soon should be entertained. Indeed, we may well be in the eye of the hurricane.

A calmness settled when Mario Draghi pledged that the euro was an irreversible project. Yet, the forces that could eventually break up the Eurozone are not only untamed but are growing in strength¹. Partly due to serious policy mistakes made by European leaders, ‘asymmetric shocks’ have grown since the beginning of the crisis, and the Eurozone still lacks a credible means of dealing with them ex post.

Lessons from the US and Eurozone experiences

A useful starting point is to compare how the US and Eurozone have been affected by and have responded to the recent financial crisis. The goods and labour markets show an instructive comparison between the US and the Eurozone.

Key to such a comparisons are notions of:

• Permanent versus transitory consequences of shocks;
• Active versus passive policy responses
• Symmetric versus asymmetric shocks.

The figure below compares US GDP (in red) with Eurozone GDP (in blue) from 2006 to 2013 (that is, the IMF’s forecast). I have normalised the initial values to 100 in order to make the comparison easier. A few points ought to be noted:

• The US recession starts earlier (2007), than in the Eurozone (2008);

The financial crisis originated in the US and later spread to the Eurozone and elsewhere.

• Despite the crisis origin, the fall in output is larger on impact in the Eurozone;
• The US economy started recovering from 2009, while in the Eurozone recovery has been short-lived, and flattens out in 2010.

As a result, US GDP in 2012 is above its 2006 level by 7%, while the Eurozone’s output in 2012 exceeds its level in 2006 only by 2%.

Figure 1. GDP

Source: Author’s calculations based on World Economic Outlook.

The labor market comparison tells an interesting story: the picture below describes the rate of unemployment in the US (blue line) and in the Eurozone (red line).

Figure 2. Unemployment

Source: Author’s calculations on World Economic Outlook.

A Pessimistic Note on the Euro

Author: Paolo Manasse · December 10th, 2012 · RGE EconoMonitor

On February 7, I gave a talk a the Conference “America: Still A European Power?” in Bologna jontly organized by Johns Hopkins University-SAIS and Bologna University. The title of my presentation was “Why and How the US and the EU Did/Didn’t Come out of the Economic Crisis”. Putting my notes together, I realized that they gave quite a pessimistic view on the sustainability of the Euro as we have come to know it. This is, more or less, what I said.
___________________

In this talk I will compare how the US and Eurozone countries (EUZ) were affected by and responded to the crisis. Thus I will not say a word on the “causes” of the current crisis. I will argue that the main differences rest in three key aspects:

1. permanent vs transitory consequences
2. active vs passive policy responses
3. symmetric vs asymmetric shocks

I will then briefly discuss some policy implications such as

1. Is the Euro sustainable?
2. What institutional reform are required?
3. Are current reforms (Banking Union, Political Union, Eurobonds) steps in the right direction?

I. The Economy

Output

Source: P.Manasse calculations on WEO

The figure on the right compares the US (red) and EUZ (blue) GDPs since 2006 (at constant prices, source WEO database October 2012), where I have normalized the initial values to 100 (click to enlarge). The figure shows that

• The US recession starts earlier than EUZ due to the subprime crisis;
• the EUZ recession is deeper on impact;
• the US recovers from 2009, while the EUZ’s recovery is short lived and ends in 2010;
• In 2012 output is above it’s 2006 level by 7% in the US and only by 2% in EUZ

The Monti Legacy

Author: Paolo Manasse · December 11th, 2012 · RGE EconoMonitor

Today I gave a talk at the Conference RENCONTRES ECONOMIQUES 2012 ”L’ajustement des déséquilibres en zone euro” at the Ministry of Finance in Paris. I discussed the legacy of the Monti government, the positive and negative aspects of the economic reforms, and some implications of the current governmernt crisis. I was very surprised to see how little the French audience actually knew about the economic and political situation in Italy. The slides of my presentations are here, or click on the below.

An essential presentation for everybody who wants to understand what happened during the Monti government (hfk)

The Probability Of A “Monti-Bis” Takes A Hit

Author: Paolo Manasse · December 2nd, 2012 · RGE EconoMonitor

The victory of Pierluigi Bersani in the primary elections for the leadership of the Democratic Party in Italy reduces the chances of the Monti Agenda.

In September I discussed in Economonitor the plausibility of a “Monti bis”, the possibility that the next Italian government will carry forward the ‘”Monti Agenda” of budgetary discipline and structural reforms, with Mario Monti still playing an important role. The probabilistic model assumes that the outcome depends on two factors: the type of electoral reform to come out of Parliament, and the leaderships of the two main parties. A proportional system would increase the chances of the “Monti bis”, because it produces weak coalition governments at parliamentary level, while a reform leading to a large majority premium would have the opposite effect. The Monti Agenda is more likely with moderate leaders in the right and left (Alfano and Renzi, respectively), and less likely with more ideological leaders (Berlusconi against Bersani allied with the extreme left).

In September, the Monti calculator gave an initial estimate for the Monti-bis probability at 43%, since
• Berlusconi seemed determined to run as the PDL candidate;
• Bersani was favored against Renzi (respectively 60% and 40% chance of being a leader of the Democratic Party);
• The debate on electoral reform favored a “proportional” system;

In November, some developments significantly altered the political framework favoring moderate leaderships and a “hung parliament”:
• Berlusconi declared that he would not run;
• Renzi popularity rose (almost to 50%);
• There electoral reform seem to favor a proportional-like system;
This led to the Monti-bis probability to exceed 50%.

But today, we have three new important features:
• Bersani won the primary elections for the Democratic party leadership possibly with the votes of the extreme left;
•Berlusconi is now more likely to run again;
• It is more likely that there will not be any electoral reform.
Consequently, as can be seen from the figure, the predicted probability of the Monti bis drops dramatically, to 30% (see the Figure).

The Things That Draghi Didn’t Say in His Milan Speech

Author: Paolo Manasse · November 16th, 2012 · RGE EconoMonitor

On Thursday, November 15, ECB head Mario Draghi gave an interesting speech in Milan, at the Bocconi University’s ceremony for the new academic year. Interesting both for what he said and for what he didn’t say. The narrative of the crisis was more or less as follows.

In the past few years, markets underestimated the consequences of the irresponsible economic policies (fiscal policies in Greece, Italy, Spain and Ireland credit) and lack of structural reforms (Greece, Portugal, Italy) in many Eurozone countries, but now the chickens have come home to roost and markets have freaked out: interest rates reflect the expectation that the peripheral countries will leave the Euro. This has fragmented the inter-bank market in Europe and prevented the ECB’s low interest rates policy to be transmitted to households and businesses in the peripheral countries. The ensuing credit crunch in these countries has triggered a vicious circle of reduced consumption, investment, GDP, tax revenue, higher deficits and further increases in interest rates. This spiral occurred, according to Draghi, despite the budgetary consolidation and structural reforms that were implemented in many countries.

The Mario-Monti-Probability-Calculator: 54%

Author: Paolo Manasse · November 8th, 2012 · RGE EconoMonitor

About a month ago I discussed in Economonitor the likelihood that the “Monti agenda” of budgetary discipline (so far large tax increases and promises of spending cuts ) and growth-oriented liberalizations (yet to be implemented) would still be at the core of agenda of the next Italian government, after the 2013 elections. In Italy, the debate is framed around the likelihood that Monti will succeed himself as prime minister (“Monti-bis”), or retain some important role, either in government (economy minister) or in politics (next president of the republic).

The probabilistic model described in my previous post was based on the idea that the outcome depends on two factors: the electoral system that will result from the ongoing parliamentary reform, and the leaderships of the two opposite left/right coalitions, which will be determined by “primary” ballots. A “proportional system” would likely result in a “hung parliament”, and this increases the chances of ”Monti-Bis” because it produces weak coalition governments. By contrast, a “majoritarian” reform would have the opposite effect. The Monti Agenda also stands a better chance if leaders chosen to lead the left and the right parties are “moderate” (Mr. Alfano on the right and Mr. Renzi on the left), rather than “extreme” (Mr. Berlusconi on the right and an alliance of Mr. Bersani and Mr. Vendola on the left).

Two important things have change since my article one month ago :

Is Mario Monti Going to be the ‘Next’ Italian Prime Minister?

 

Author: Paolo Manasse · September 21st, 2012 · RGE EconoMonitor

Professor of Economics at the University of Bologna

Investors and political leaders around the world are very worried that the new government that will emerge from the next Italian elections in April 2013 will not be headed by Mario Monti, nor pursue the “Monti Agenda” of structural reform and fiscal discipline. The worries are well founded, for several reasons.

Economics..

• On one hand it is hard to conceive that the ECB plus ESM bazooka of bond purchases in the secondary and primary sovereign debt markets may be sufficient to prevent a breakup on the Eurozone, should investors perceive that the new Italian government lacks a strong commitment to reforms (see Manasse and Zavalloni (1), Manasse and Trigilia (2)), and that it may revert to the old path of low productivity growth and high deficits. Spreads would sky-rocket until the bazooka becomes politically useless. The Euro would not stand the pressure.
• On the other hand, the Monti’s “agenda” (Latin for “things to be done”) is far being a Monti’s’ “acta” (“things that have been done”). So far the Government has managed to push through Parliament seven Reforms: Budget Consolidation and Pension Reform (“Save Italy”), Competition (“Grow Italy”), Administrative and Fiscal Simplification, Labor Market Reform, Spending Review, Growth. Yet a recent inquiry the Sole 24 ore daily newspaper found as of August 31^st, about 86.6 percent (!) of the decrees required to implement these reforms have yet to approved, with implementation lags particularly serious in the crucial labor and spending review reforms. In other words, the job is far from finished.
• Finally, while the tax increase and the pension reforms have already displayed their negative impact on consumption and output (according to my rule-of-thumb evaluation, they may have depressed GDP growth by up to -2%), the much hoped-for positive effects on medium term growth (+1.5 according to me) of the other reforms have not yet materialized and may be dissipated if interest rate rise back. Thus should the reform drive fade away, only the negative impact effect would be left?

Time for international monetary coordination

Paolo Manasse,3 September 2012, voxeu

Professor of Macroeconomics and International Economic Policy at the University of Bologna

The Eurozone crisis threatens not just European economies but economies all over the world. This column argues that a global problem calls for a global solution – and the solution this time round is monetary policy. The ECB needs to commit to keeping sovereign debt yields within reason while the Federal Reserve needs to work towards lowering long-term yields.

Many observers of the European Sovereign debt saga had long realised that the ECB was the only European institution up to the task of avoiding a breakup of the euro (see for instance Eichengreen 2009 on this site). The newly forged institutions, the ESFS/ESM, are both ill designed and inadequately funded (Manasse 2011).

The sharp criticism of German piecemeal approach, however, forgets that the ECB was created “in the image and likeness” of the Bundesbank; price stability is its core mandate. That was the price to be paid for convincing Germany to give up the Deutsche mark, and to share the same currency with inflation- and deficit-prone Italy. Now that the survival of the euro seems to hinge on the monetisation of southerners’ public debt, one way or another (primary or secondary purchases, anti-spread firewall), it is not surprising that the Bundesbank, backed by the FDP and CSU parties, is simply saying “no”. Weidman’s alleged resignation just proves the case.

Merkel’s dilemma

A Spread-Fixing Scheme: Monti’s Pyrrhic Victory?

 

Author: Paolo Manasse · July 2nd, 2012 · voxeu

Just as with Italy’s football team, Mario Monti has been hailed for beating the Germans – in his case at the recent EU summit. But this column argues that, just as with the football, Italy’s victory over Germany may soon lead to disaster.

Together with Mario Balotelli, the football player, Mario Monti was heralded in Italy for bashing Germany, in his case at the recent EU summit. For Monti’s supporters, the satisfaction stemmed from achieving an explicit mandate for the EFSF/ESM to ‘stabilise’ yields differentials by intervening in the primary and secondary market. Yet, as in the case of Italy’s ephemeral victory against the German soccer team, which preceded a disastrous defeat against Spain, Mario Monti’s achievement with the ESM may turn out similarly doomed. This is why.

The interpretation of the summit communiqué is, as usual, not very transparent. It says:

“We affirm our strong commitment to do what is necessary to ensure the financial stability of the euro area, in particular by using the existing EFSF/ESM instruments in a flexible and efficient manner in order to stabilise markets for Member States respecting their Country Specific Recommendations and their other commitments including their respective time lines, under the European Semester, the Stability and Growth Pact and the Macroeconomic Imbalances Procedure. These conditions should be reflected in a Memorandum of Understanding. We welcome that the ECB has agreed to serve as an agent to EFSF/ESM in conducting market operations in an effective and efficient manner. We task the Eurogroup to implement these decisions by 9 July 2012.”

Although the details shall be filled by July 2012, some educated guesses are possible: