By Christophe Blot and Xavier Timbeau

In parallel with the decisions taken by the US Federal Reserve and the European Central Bank (ECB), governments are stepping up announcements of stimulus packages to try to cushion the economic impact of the Covid-19 health crisis, which has triggered a recession on an unprecedented scale and pace. The confinement of the population and the closure of non-essential businesses is leading to a reduction in hours worked and in consumption and investment, combining a supply shock and demand shock.

The responses to the crisis in both the US and Europe are unfolding over time, but the choices already made on either side of the Atlantic have lessons about their ideologies, the fundamental characteristics of their economies and the functioning of their institutions.

Federal budget: whether or not to have one

After several days of negotiations between Democrats and Republicans, the US Congress approved a plan to support the economy worth 2,000 billion dollars (9.3 points of GDP) [1]. It provides, in particular, for transfers to households, loans to SMEs and measures to support sectors in difficulty in the form of deadline extensions. On the other side of the pond, the European Commission has proposed the creation of a 37-billion euro fund as part of an investment initiative. The EU will also reallocate one billion euros “as a guarantee to the European Investment Fund to incentivise banks to provide liquidity to SMEs and midcaps” [2]. EU-wide, these sums represent 0.2 percentage point of GDP, which may seem all the more derisory since this does not involve allocating additional funds but rather reallocating funds within the budget.

These major differences point out in the first place that, by construction, the European budget is limited, and that it is not set up to respond to an economic slowdown affecting all the Member States. Within the EU, fiscal prerogatives are the responsibility of the Member States, as are the main sovereign instruments for responding to a crisis.

It is the national budgets that are used to prop up economic activity. So turning to these and bringing together announcements made at the level of the EU’s five largest countries, the total sum allocated exceeds 430 billion euros (3.3% of GDP), to which must be added guarantees, which could come to more than 2,700 billion euros, or more than 20 points of EU GDP [3]. The measures taken by the US and by European countries are thus on a comparable order of magnitude and are distinguished by the level at which they are taken as well as by the way in which the sums are allocated. In the United States, the federal budget represents 33% of GDP, which makes it possible to carry out a common, centralized action that benefits all households and businesses, based on decisions approved by Congress, in a way that implicitly ensures stabilization between the different States. In practice, the taxes paid by households and businesses in the States hit hardest will fall relatively, and these same States will also be able to benefit more from certain federal measures. Moreover, the US Congress can vote a deficit budget, which can be used to implement intertemporal stabilization measures [4].

In contrast, the EU does not have the capacity to go into debt, whereas the Member States can. Their stabilization capacity can be constrained by the difficulty of self-financing, which initially leads to a rise in interest rates or subsequently to the drying up of markets. The different Member States are not on an equal footing in the markets, due to their macroeconomic situation or to the level of their debt, as in the case of Italy. But beyond these differences, the main issue is that savers, through the financial markets, can make trade-offs between the debts of different countries within a legal space (the EU) that guarantees the free movement of capital, so interest rate movements can amplify small macroeconomic differences and fuel self-actuating dynamics. The 2012 sovereign debt crisis showed that a contagion by sovereign rates, which, after Greece, sucked Italy and Spain into a whirlpool of doubt in the financial markets, could lead to substantial transfers from countries in difficulty to countries considered virtuous. The counterpart of the trade-off was the lowering of rates for Germany and France. These transfers can amount to several points of GDP, a level that is creating a risk of the break-up of the euro zone: it might be preferable to end the free movement of capital, so as to capture national savings to finance the public debt (and therefore monetize the public deficit) rather than letting the debt load soar and having to submit to a humiliating recovery plan in exchange for European aid.

The surge in Italian sovereign rates, prior to the clarification by the ECB’s announcement, then logically enough relaunched the debate about the possibility of issuing euro-bonds (called “corona-bonds”), which would make it possible to pool part of the budgetary expenditures of the euro zone States so as to avoid this wholly unjustified spiral of trade-offs between sovereign debts, whose impact could be sufficient to lead to the break-up of the euro zone.

As long as these common debt securities are not set up or the ECB is reluctant to intervene to buy back this or that European public debt, the role of Europe’s institutions will be on another scale. First of all, what is needed is to promote the coordination of decisions taken by the Member States and to encourage governments to take strong measures to avoid stowaways who expect to benefit from measures taken by their neighbours [5]. These effects are likely to be limited, however, and it is hard to imagine that a country will not take the steps necessary to directly help households and businesses cope with the shock.

More than coordination, it is essential to soften the fiscal rules announced and in force in order to give the Member States the manoeuvring room they need by invoking the exceptional circumstances clause. Furthermore, beyond a short-term response, it is important that the crisis does not provide an opportunity to exert pressure for greater fiscal discipline. The legitimacy of the Member States in the crisis and the relevance of their responses will be closely scrutinized after the crisis. The EU must not engage in an untimely debate that could lead only to compromising its political legitimacy definitively.

Since there is no tool for pooling debt, the ECB plays a crucial role in maintaining a low level of interest rates for all the States of the Union, both today and tomorrow.

Adapting plans to the way the labour market function

Beyond the sums committed and the institutional level at which decisions are taken, the content of the respective plans is a reminder that the labour markets function very differently on the two sides of the Atlantic. The euro zone Member States have favoured the use of short-time working, or partial unemployment, which keeps workers employed and socializes the loss of income at source. The productive fabric is preserved because there is no breach of the employment contract, and the States offer, based on existing mechanisms, partially to make up lost wages in order to maintain consumer purchasing power. These mechanisms, already in wide use in Germany and Italy, have recently been expanded in France and developed in Spain. This approach should provide better conditions for the economy to re-start once the recession is over, since companies will already have a workforce, thus avoiding the costs of recruitment and training.

In the United States, these mechanisms are not widespread, and the American labour market is very flexible. Notice times for dismissing employees are very short, so that companies can quickly adjust their demand for work. The drop-off in activity will quickly translate into a higher unemployment rate, as is indicated by the initial increases recorded by the federal employment agency (see the figure). In two weeks, the cumulative number of registered unemployed exceeded 10 million, much more than what was observed after the bankruptcy of Lehman Brothers in September 2008 or following the burst of the Internet bubble in 2000. Furthermore, the duration of unemployment benefits, set at the State level [6], is generally shorter, which quickly puts households at risk of a loss of income. This is why a large part of the measures enacted in the aid plan approved by Congress provide for direct support to households through transfers or tax cuts, based on their income level. The measures also provide for the extension of benefit periods and additional assistance to laid-off workers, which may be added to the benefits received under standard unemployment insurance. But rather than directly targeting those losing their jobs, these are broad spectrum measures. A vigorous recovery plan will no doubt be necessary after the health crisis. But here, too, the windfall effects will consume a large part of the stimulus, and it will be very expensive to get the economy back on its pre-crisis footing.

As the November elections approach, these choices also probably explain why Donald Trump sometimes seems reluctant to prolong the confinement of Americans, arguing that the economic crisis could do more damage than the health crisis [7]. But by letting the virus spread, the number of people infected with a serious illness risks exploding and exposing the United States to a major health crisis. It is not certain that the US President’s record will prove to be more favourable, or the US strategy more effective, whether in terms of health or economics.

[1] This plan builds on previous measures, whose value totalled just over USD 100 billion. This includes all measures for households and businesses (loans and liquidity support).

[2] See https://ec.europa.eu/commission/presscorner/detail/en/IP_20_459

[3] It should also be noted that certain measures were
taken based on an assumed duration of confinement, and that these could
therefore be recalibrated depending on how the situation evolves.

[4] The vast majority of States, however, have deficit
or debt constraints. Faced with the scale of the crisis, some of them are also
freeing up spending which can therefore be adjusted to the federal support
plan.

[5] If country A decides to increase its spending, country B can hope to partially benefit by the increase induced in country A’s imports from B, particularly if B is small compared to A.

[6] The US unemployment insurance system is specific
to each of the States. The federal government plays its role in managing the
costs of the system as a whole. See Stéphane Auray and David L. Fuller (2015): “L’assurance chômage aux Etats-Unis”.

[7] See here for an analysis of the economic and health risks.

By Fergus Cumming (Bank
of England) and Paul Hubert (Sciences Po – OFCE, France)

Does the transmission
of monetary policy depend on the state of consumers’ debt? In this post, we
show that changes in interest rates have a greater impact when a large share of
households face financial constraints, i.e. when households are close to their
borrowing limits. We also find that the overall impact of monetary policy
depends in part on the dynamics of real estate prices and may not be
symmetrical for increases and decreases in interest rates.

From
the micro to the macro

In a recent
article, we use home loan
data from the United Kingdom to build a detailed measure of the proportion of
households that are close to their borrowing limits based on the ratio of mortgage
levels to incomes. This mortgage data allows us to obtain a clear picture of the
various factors that motivated people’s decisions about real estate loans
between 2005 and 2017. After eliminating effects due to regulation, bank
behaviour, geography and other macroeconomic developments, we estimate the
relative share of highly indebted households to build a measure that can be
compared over time. To do this, we combine the information gathered for 11
million mortgages into a single time series, thus allowing us to explore the
issue of the transmission of monetary policy.

We use the time
variation in this debt variable to explore whether and how the effects of
monetary policy depend on the share of people who are financially constrained. We
focus on the response of consumption in particular. Intuitively, we know that a
restrictive monetary policy leads to a decline in consumption in the short to
medium term, which is why central banks raise interest rates when the economy
is overheating. The point is to understand whether this result changes
according to the share of households that are financially constrained.

Monetary
policy contingent on credit constraints

We find that monetary
policy is more effective when a large portion of households have taken on high levels
of debt. In the graph below, we show how the consumption of non-durable goods, durable
goods and total goods responds to raising the key interest rate by one
percentage point. The grey bands (or blue, respectively) represent the response
of consumption when there is a large (small) proportion of people close to
their borrowing limits. The differences between the blue and grey bands suggest
that monetary policy has greater strength when the share of heavily indebted households
is high.

It is likely that there are at least two mechanisms behind this differentiated effect: first, in an economy where the rates are partly variable[1], when the amount borrowed by households increases relative to their income, the mechanical effect of monetary policy on disposable income is amplified. People with large loans are penalized by the increase in their monthly loan payments in the event of a rate hike, which reduces their purchasing power and thus their consumption! As a result, the greater the share of heavily indebted agents, the greater the aggregate impact on consumption. Second, households close to their borrowing limits are likely to spend a greater proportion of their income (they have a higher marginal propensity to consume). Put another way, the greater the portion of your income you have to spend on paying down your debt, the more your consumption depends on your income. The change in income related to monetary policy will then have a greater impact on your consumption. Interestingly, we find that our results are due more to the distribution of highly indebted households than to an overall increase in borrowing.

Our results also
indicate some asymmetry in the transmission of monetary policy. When the share
of constrained households is large, interest rate increases have a greater
impact (in absolute terms) than interest rate cuts. This is not completely surprising.
When your income comes very close to your spending, running out of money is very
different from receiving a small additional windfall.

Our results also
suggest that changes in real estate prices have significant effects. When house
prices rise, homeowners feel richer and are able to refinance their loans more
easily in order to free up funds for other spending. This may offset some of
the amortization effects of an interest rate rise. On the other hand, when
house prices fall, an interest rate hike exacerbates the contractionary impact on
the economy, rendering monetary policy very powerful.

Implications
for economic policy

We show that the state
of consumers’ debt may account for some of the change in the effectiveness of
monetary policy during the economic cycle. However, it should be kept in mind
that macro-prudential policy makers can influence the distribution of debt in
the economy. Our results thus suggest that there is a strong interaction
between monetary policy and macro-prudential policy.

[1]
Which is the case in the United Kingdom.

By Eloi Laurent

On September 18^th 2019, 16 years old climate activist Greta Thunberg appeared before the United States House of Representatives. When asked to submit a formal version of her inaugural statement, she replied that she would be giving lawmakers a copy of the IPPC special report on the impacts of global warming of 1.5 °C, the so-called “SR 1.5“. “I am submitting this report as my testimony because I don’t want you to listen to me, I want you to listen to the scientists”, she said eloquently.

By the same token, when asked what words she wanted to be printed on the sails of the boat carrying her across the Atlantic Ocean from Sweden to the US, she asked for a blunt message urging citizens and policymakers to act upon climate knowledge: “Unite behind Science”. Greta Thunberg deserves considerable praise for her intelligence, courage and determination in the face of ignorance, skepticism and animosity. But she is wrong on one important point: nations and people around the world won’t unite behind science. They will only unite behind justice.

Any meaningful conversation among humans about reform, change and progress starts with debating justice principles at play and imagining institutions able to embody these principles. This is especially true of the titanic shift in attitudes and behaviors required by the climate transition, which goal is nothing short of saving the hospitality of the planet for humans.

Climate injustice is obvious in our world. On the one hand, a handful of countries, about ten percent (and a handful of people and industries within these countries) are responsible for 80% of human greenhouse gas emissions, causing climate change that is increasingly destroying the well-being of a considerable part of humanity around the world, but mostly in poor and developing nations. On the other hand, the vast majority of the people most affected by climate change (in Africa and Asia), numbering in the billions, live in countries that represent almost nothing in terms of responsibility but are highly vulnerable to the disastrous consequences of climate change (heat waves, hurricanes, flooding) triggered by the lifestyle of others, thousands of miles away.

Why is climate change still not mitigated and actually worsening before our eyes, while we have all the science, technology, economics, and policy tools we need to fix it? Largely because the most responsible are not the most vulnerable, and vice-versa.

And yet, the time may be ripe for climate justice to take center stage in international negotiations. Data compiled by the Global Carbon Project released last week show that top emitters are converging in terms of climate responsibility (table 1).

Of course, China remains by far the first polluter: the country has emitted in 2018 roughly twice the volume of CO2 than the US, thrice the amount of the EU, four times the amount of India, five times the amount of Russia. Consider the amount per capita, and the picture changes dramatically: a citizen of the United States emits more than twice CO2 than a Chinese. And yet, for the first time, a European is (slightly) less responsible than a Chinese in terms of per capita emissions. Conversely, it is well established that historical responsibility for greenhouse gas emissions falls largely on the shoulders of Western countries, with the US and the EU jointly responsible for half of emissions since the industrial revolution, while China only accounts for less than 15%. And yet, for the first time, China is as responsible as the US when emissions are counted since 1990 onwards (both countries accounting for 20% each of emissions over the 1990-2018 period).

It is thus the right time to devise actionable equity criteria, commonly agreed upon top emitters, as to how distributing the remaining “carbon budget” (the overall amount of emissions remaining before the Earth’s climate reaches a catastrophic tipping point, approximately 1200 billion tons of carbon that remain to be emitted over the next three decades so as to limit the rise of ground temperatures to around 2 degrees by the end of the 21st century).

But as incredible as it may seem, the formal global conversation has not yet started on climate justice: as the COP 25 ends in Madrid and all eyes turn to COP 26 for a renewed climate ambition, countries are still negotiating at the UN on volumes of emissions that do not take into account current and projected population, human development level, geographic basis (production vs. consumption emissions), historical responsibility, etc. By the same token, The Paris Agreement (2015) mentions the term “justice” only a single time, to affirm that signatories recognize “the importance for some of the concept of ‘climate justice’”. This is clearly a misinterpretation. The whole point of climate justice is precisely that it is not confined to a few nations or important for a few people: it should be the concern of all involved in climate negotiations.

It can be shown that the application of a hybrid but relatively simple model of climate justice based on five criteria would lead to substantially cutting global emissions in addition to the carbon budget (by 36%) over the next three decades which would ensure meeting the goal of 2 degrees, and even targeting 1.5 degrees, thereby enhancing the fairness of this common rule with respect to the most vulnerable countries and social groups (see table 2).

As available data make clear, we are collectively missing the wrong targets on climate. Even if all countries fulfilled their pledges and reach their targets, the increase in temperatures would still be of 3 degrees by the end of the 21^st century (or twice the target agreed upon at the Paris Agreement in 2015). In other words, what is lacking is not just the political will but also the imagination. Climate justice is the way out of this impasse. Climate justice is the key to understanding and eventually solving the urgent climate crisis. Climate justice is the solution to climate change.

By Guillaume
Allègre

The issue of
inequality is once again at the heart of economists’ concerns. Trends in
inequality and its causes and consequences are being amply discussed and debated.
Strangely, there seems to be a relative consensus about how to measure it [1]. Economists working on inequality use in
turn the Gini index of disposable income, the share of income held by the
richest 10%, the inter-decile ratio, and so on. All these measures are relative
in character: If the income of the population as a whole is multiplied by 10,
the indicator doesn’t change. What counts is the income ratio between the
better off and the less well off. But could inequality
and the way it changes be measured differently?

France’s inequality
monitoring body is currently discussing not only trends in the
income ratio between the more and less well-off, but also changes in the income
gap: “In one year, the richest 10% receive on average about 57,000 euros, and
the poorest 10% 8,400 euros: a difference of 48,800 euros, equivalent to just
over 3.5 years of work paid at the minimum wage (Smic). This gap rose from 38,000 euros in 1996 to 53,000 euros in
2011, then fell to 48,800 euros in 2017.” Measuring changes in the income
gap does not seem relevant. Let’s take two people with incomes of 500 and 1,000
euros, then multiply their incomes by 10: the income ratio is stable, but the
income gap is multiplied by 10. Has inequality increased, is it stable or has
it decreased? Using the income gap as a measure, it has increased, but it is
stable according to the ratio. We believe it may have actually
decreased.

Indeed, in France
today, the differences in living conditions, lifestyles and well-being are perhaps
greater between someone with an income of 500 euros, which leaves them in dire poverty,
and someone with an income of 1,000 euros, which puts them at the poverty line,
than between a person with an income of 5,000 euros, who can be described as
well-off, and a person earning 10,000 euros, who can be described as very
well-off. These last two people share similar lifestyles, even if the latter probably
lives in a slightly larger and better-situated home, and frequents more
luxurious restaurants. In other words, subtracting 10% of income from a very
wealthy person probably has less impact than subtracting 10% from someone at the
poverty line. There is abundant literature on risk aversion showing that people
are willing to pay more than 10% of their income when it is high to protect
against a 10% drop in income when it is low. This is, moreover, one of the justifications for a progressive
tax: a greater percentage is taken from the better off, but the sacrifice is
supposed to be equal because, according to marginalist theory, contributive
capacity grows faster than income (or utility increases less than
proportionately compared to income).

If this argument
is accepted, we could conclude that at a constant level of relative inequality
(Gini index, income ratio between the richest and poorest), all other things being equal, a richer
society would in practice be more egalitarian, in the sense that its citizens share
a more comparable way of life or well-being. Intuition tells us that this is
true for large gaps in wealth (such as the 10-fold increase in earnings in the example
above). If this is true, then comparisons of relative inequality made over very
long periods of time or between developed and developing countries need to be kept
in perspective. When Thomas Piketty
shows that the richest 10% captured 50% of income between 1780 and 1910, we
could then conclude that inequality has decreased over that period!

Milanovic and Milanovic, Lindert
and Williamson
have developed concepts that take into account this wealth effect over a very
long-term historical perspective: the “inequality frontier” is the maximum
inequality possible in a society taking into account the fact that the society
must guarantee the livelihoods of its poorest members (the minimum income to
live): in an economy with very little surplus (where the average discretionary income
is low), the maximum possible inequality will be low [2]; in a very well-off economy, the maximum possible
Gini coefficient will be close to 100 percent [3]. The “extraction ratio” is the current
Gini divided by the maximum possible Gini. The wealthier a country is, the lower
the maximum possible Gini coefficient, and the more – at equal Ginis – the
extraction ratio will be low. One could also calculate a “discretionary income
Gini” (in the sense of disposable income minus the minimum subsistence
income) [4].

It can be argued that
when comparing inequality in two societies at different levels of development,
the extraction ratio is a better indicator of inequality than the available
income Gini [5] or other indicators of relative inequality.
One conclusion reached by Milanovic et al.: “Thus, although inequality in historic
preindustrial societies is equivalent
to that of industrial societies today, ancient inequality was much larger when
expressed in terms of maximum feasible inequality. Compared to the maximum feasible
inequality, current inequality is much lower than that in ancient societies”.
According to the authors, in the early 2000s, the maximum possible Gini was
55.7 in Nigeria and 98.2 in the US: the comparison of inequality between the
two countries will then be very different depending on whether the indicator
chosen is the income Gini or the extraction ratio. On the other hand, there
will be little difference between the United States and Sweden (maximum
achievable Gini of 97.3) despite an average income difference of 45%. The
effect is in fact saturated since the Swedish income is already 40 times the
subsistence minimum (400 dollars per year in purchasing power parity) and the
American, 58 times. In the authors’ approach, the subsistence minimum is set in
purchasing power parity and is fixed between countries and over time. But is
the subsistence minimum really 400 dollars a year in Sweden today? When
comparing inequality in the United States and Sweden today, is this subsistence
minimum relevant? Taking a significantly higher minimum level of subsistence
could change the comparison of inequality, even in developed countries (for a comparable
living standards Gini, is Switzerland really more egalitarian than France?).
The problem then is to establish a minimum subsistence income amount [6].

The choice of an
inequality indicator depends on the objective pursued. If the idea is to
compare inequalities in living conditions across time or between countries, the
discretionary income Gini might be relevant. On the other hand, if there is concern
that excessively high incomes present a danger for democracy (a position
developed in particular by Stiglitz in The Price
of Inequality), the measure of relative inequality as calculated by
the share of income captured by the wealthiest 1% seems more relevant.

When comparing countries
that are closely related in terms of development, there are other, perhaps more
important, limitations to comparing living standard Ginis. Given the same
income inequality, a country where public spending on health, housing, education,
culture, etc. is higher will (probably) be more egalitarian (unless public
spending goes disproportionally to the better off). The issue of housing is
also important, as it weighs heavily in household budgets: all other things being
equal, high rents due to a constrained housing supply will increase inequality
(tenants are poorer on average today). But it is difficult to take into account
this effect in comparisons or trends, because the price of housing may reflect an
improvement in quality or better amenities. In addition, inequality between
landlords and tenants is not taken into account in the usual calculation of the
standard of living: with equal income, an owner who has finished repaying the
mortgage is better off than a tenant, but the fictitious rent that the owner receives
does not enter the calculation of their standard of living. Finally, and
without being exhaustive, the issue of hours of work and household production
also complicates the equation: a difference in income can be linked to a
difference in working hours, especially if one of the spouses in a couple (most
often the woman) is inactive or works part-time. However, the inactive spouse
can engage in household production (including childcare) that is not taken into
account in statistics: the difference in standard of living with the bi-active
couple is less than what is implied by the difference in incomes. Statistics do
not usually take this effect into account because it is difficult to assign a
value to household production.

It can be seen that
the measurement of income and the standard of living, and therefore inequality,
is imperfect. The wealth effect (at an equal standard of living Gini, a richer
society is probably more egalitarian, all things being equal) is a limit, among
others, some of which are probably more important when comparing developed
economies. On the other hand, this wealth effect could be relatively significant
if one wants to compare inequalities in living conditions between the France of
1780 and that of 1910 and a fortiori of today.

[1] Whereas it was prominent from the early 1970s to the end of the
1990s: see in particular the work of Atkinson, Bourguignon, Fleurbaey and Sen.

[2] Milanovic et al.
give the following example: consider a society of 100 individuals, 99 of whom are
in the lower class. The subsistence minimum in this society is 10 units and the
total income 1,050 units. The sole member of the upper class receives 60 units.
The Gini coefficient associated with this distribution (the maximum possible Gini)
is only 4.7 percent.

[3] In fact, the
maximum possible Gini rises quickly: if in the previous country, the income
increases to 2,000 units and the dictator extracts all the surplus (1,010
units), the Gini leaps to 49.5.

[4] The disposable
income Gini, or the extraction ratio, shares some of the characteristics of the
Atkinson
index, including the idea of differentiating among the wealthiest
and the poorest. Nevertheless, the Atkinson index remains a relative indicator
of inequality: if all incomes are multiplied by 10, the indicator remains
constant. The index satisfies average independence, which is generally sought
among inequality indicators, but which we seek to go beyond here.

[5] The two indicators
do not measure the same concepts. First, it may be interesting to use several
indicators, but multiplying the number of indicators raises the problem of
readability, so one must choose. The choice of an indicator is based on a
normative judgment since, at least implicitly, the idea is to reduce inequality
according to the measure chosen (there is a consensus among economists that,
all else being equal, less inequality is preferable).

[6] Especially since
this income must be consistent over time or between countries if the objective
is to capture a trend or make a comparison.

By Whelsy Boungou

It has been five years since commercial banks, in
particular those in the euro zone, have faced a new challenge, that of
continuing to generate profit in an environment marked by negative interest
rates.

At the onset of the 2007-2008 global financial
crisis, several central banks implemented new “unconventional”
monetary policies. These consisted mainly of massive asset purchase programmes
(commonly known as Quantitative Easing, QE) and forward guidance on interest
rates. They aimed to lift the economies out of crisis by promoting better economic
growth while avoiding a low level of inflation (or even deflation). Since 2012,
six central banks in Europe (Bulgaria, Denmark, Hungary, Sweden, Switzerland
and the European Central Bank) and the Bank of Japan have gradually introduced
negative interest rates on bank deposits and reserves, in addition to the unconventional
measures already in force. For example, the ECB’s deposit facility rate now stands
at -0.40% (see Figure 1). Indeed, as indicated by Benoît Cœuré [1], the
implementation of negative rates aim to tax banks’ excess reserves to encourage
them to use these to boost the credit supply.

However, the implementation of negative rates has
raised at least two concerns about the potential effects on bank profitability
and risk-taking. First, the introduction of negative rates could hinder the
transmission of monetary policy if this reduces banks’ interest margins and
thus bank profitability. In addition, the lowering of credit rates for new
loans and the revaluation of outstanding loans (mainly at variable rates)
reduces banks’ net interest margin when the deposit rate cannot fall below the Zero
Lower Bound. Second, in response to the impact on margins, the banks could
either reduce the share of nonperforming loans on their balance sheets or look
for other assets that are more profitable than loans (“Search-for-yield”).
In a
recent article
[2], we used panel data from 2442 banks from the 28 member countries of the
European Union over the period 2011-2017 to analyse the effects of negative
rates on bank behaviour with respect to profitability and risk-taking.
Specifically, we asked ourselves three questions: (1) What is the impact of
negative rates on banks’ profitability? (2) Would negative rates encourage
banks to take more risks? (3) Would the pressure on net interest margins from
negative rates encourage banks to take more risk?

At the conclusion of our analysis, we highlight the
presence of a threshold effect when interest rates fall below the zero bar. As
can be seen in Figure 2, a 1% reduction in the central bank deposit rate
reduced banks’ net interest margins by 0.429% when rates are positive, and by
1.023% when they are negative. Thus, negative rates have a greater impact on
banks’ net interest margins than do positive rates. This result points to the
presence of a threshold effect at zero. In addition, in response to this
negative effect on margins (and in order to offset losses), the banks responded
by expanding their non-interest rate activities (account management fees,
commissions, etc.). As a result, in the short and medium term there was no indication
that the banks resorted to riskier positions. However, the issue of risk-taking
may eventually arise if negative rates persist for a long time and the banks
continue to suffer losses on net interest margins.

[1] Coeuré  B. 
(2016). Assessing the implication of negative interest rates. 
Speech at the Yale Financial Crisis Forum in New Haven.
July 28, 2016.

[2] Boungou W. (2019). Negative Interest Rates, Bank Profitability and
Risk-taking. Sciences Po OFCE Working Paper no. 10/2019.

By Jérôme Creel and Mehdi El Herradi

A few weeks before Christine Lagarde assumes the
presidency of the European Central Bank (ECB), it may be useful to examine the
balance sheet of her predecessors, not only on macroeconomic and financial
matters but also with respect to inequality. In recent years, the problem of
the redistributive effects of monetary policy has become an important issue,
both academically and at the level of economic policy discussions.

Interest in this subject has grown in a context
marked by the conjunction of two factors. First there has been a persistent
level of inequality in wealth and income, which has been hard to reduce. Then there are the activities
of the central banks in the advanced economies following the 2008 crisis to
support growth, particularly through the implementation of so-called “unconventional”
measures [1]. These measures, mainly manifested in quantitative
easing (QE) programmes, are suspected to have increased the prices of financial
assets and, as a result, favoured wealthier households. At the same time, the
low interest rate policy could have resulted in a reduction in interest income
on assets with fixed yields, most of which are held by low-income households. On
the other hand, the real effects of monetary policy, particularly on changes in
the unemployment rate, could help keep low-income households in employment. The
ensuing debate, which initially broke out in the United States, also erupted at
the level of the euro
zone after the ECB launched
its QE programme.

In a recent
study focusing on 10 euro zone
countries between 2000 and 2015, we analysed the impact of the ECB’s monetary
policy measures – both conventional and unconventional – on income inequality. To
do this, we drew on three key indicators: the Gini coefficient, both before and
after redistribution, and an interdecile ratio (the ratio between the richest
20% and the poorest 20%).

Three main results emerge from our study. On the
one hand, a restrictive monetary policy has a modest impact on income
inequality, regardless of the indicator of inequality used. On the other hand,
this effect is mainly due to the southern European countries, especially in the
period of conventional monetary policy. Finally, we found that the
redistributive effects of conventional and unconventional monetary policies do
not differ significantly.

These results thus suggest that the monetary
policies pursued by the ECB since the crisis have probably had an insignificant
and possibly even favourable impact on income inequality. The forthcoming
normalization of the euro zone’s monetary policy could, on the contrary,
increase inequality. Although this increase may be limited, it is important
that decision-makers anticipate it.

[1] For an analysis of the expected impact of the
ECB’s unconventional policies, see Blot et al. (2015).

By Magali Dauvin and Hervé Péléraux

In the spring of 2019, the OFCE forecast real GDP growth of 1.5% for 2019 and 1.4% for 2020 (i.e. cumulative growth of 2.9%). At the same time, the average forecast for the two years compiled by Consensus Forecasts[1] was 1.3% each year (i.e. 2.6% cumulative), with a standard deviation around the average of 0.2 points. This difference has led some observers to describe the OFCE forecasts as “optimistic as usual”, with the forecasts of the Consensus or institutes with less favourable projections being considered more “realistic” in the current economic cycle.

A growth forecast is the result of a research exercise and is based on an assessment of general trends in the economy together with the impact of economic policies (including budget, fiscal and monetary policies) and exogenous shocks (such as changes in oil prices, social disturbances, poor weather, geopolitical tensions, etc.). These evaluations are themselves based on econometric estimations of the behaviour of economic agents that are used to quantify their response to these shocks. It is therefore difficult to comment on or compare the growth figures issued by different institutes without clearly presenting their analytical underpinnings or going into the main assumptions about the trends and mechanisms at work in the economy.

However, even if the rigour of the approach underlying the OFCE’s forecasts cannot be called into question, it is legitimate to ask whether the OFCE has indeed produced chronic overestimations in its evaluations. If such were the case, the forecasts published in spring 2019 would be tainted by an optimistic bias that needs to be tempered, and the OFCE should readjust its tools to a new context in order to regain precision in its forecasts.

No systematic overestimation

Figure 1 shows the cumulative forecasts of French GDP by the OFCE for the current year and the following year and then compares these with the cumulative results of the national accounts for the two years. In light of these results, it can be seen that the OFCE’s forecasts do not suffer from a systematic bias of optimism. For the forecasts conducted in 2016 and 2017, the growth measured by the national accounts is higher than that anticipated by the OFCE, which, while revealing an error in forecasting, does not constitute an overly optimistic view of the recovery.

The opposite can be seen in the forecasts in 2015 for 2015 and 2016; the favourable impact of the oil counter-shock and of the euro’s depreciation against the dollar during the second half of 2014 was indeed slower to materialize than the OFCE expected. The year 2016 was also marked by one-off factors such as spring floods, strikes in refineries, the tense environment created by the wave of terrorist attacks and the announcement that certain tax depreciation allowances for industrial investments would end.

In general, there is no systematic overestimation of growth by the OFCE, although some periods are worth noting, such as the years 2007 and 2008 when the negative repercussions of the financial crisis on real activity were not anticipated by our models during four consecutive forecasts. Ultimately, of the 38 forecasts conducted since March 1999, 16 show an overestimate, or 40% of the total, with the others resulting in an underestimation of growth.

Forecasts relatively in line with the final accounts

Furthermore, the accuracy of the forecasts should not be evaluated solely in relation to the provisional national accounts, as INSEE’s initial estimates are based on a partial knowledge of the real economic situation. They are revised as and when the annual accounts and tax and social information updates are constructed, which leads to a final, and therefore definitive, version of the accounts two-and-a-half years after the end of the year[2].

Table 1 compares the forecasts made by the OFCE and the participating institutions in the spring of each year for the current year and assesses their respective errors first vis-à-vis the provisional accounts and then vis-à-vis the revised accounts. On average since 1999, the OFCE’s forecasts have overestimated the provisional accounts by 0.25 points. The forecasts from the Consensus appear more precise, with an error of 0.15 point vis-à-vis the provisional accounts. On the other hand, compared to the definitive accounts, the OFCE’s forecasts appear to be right on target (the overestimation disappears), while those from the Consensus ultimately underestimate growth by an average of 0.1 points.

Statistical analysis conducted over a long period thus shows that, while there is room for improvement, the OFCE’s forecasts are not affected by an overestimation bias when assessing their accuracy with respect to the final accounts.

[1] The Consensus Forecast is a publication of Consensus Economics that compiles the forecasts of the world’s leading forecasters on a large number of economic variables in about 100 countries. About 20 institutes participate for France.

[2] At the end of January 2019, the INSEE published the accounts for the 4th quarter of 2018, which provided a first assessment of growth for 2018 as a whole. At the end of May 2019, the accounts for the year 2018, calculated based on the provisional annual accounts published mid-May 2019, were revised a first time. A new revision of the 2018 accounts will take place in May 2020, and then a final one in 2021 with the publication of the definitive accounts. For more details on the National Accounts revision process, see Péléraux H., « Comptes nationaux : du provisoire qui ne dure pas », [The national accounts : provisional accounts that don’t last], Blog de l’OFCE, 28 June 2018.

By Pierre Aldama and Jérôme Creel

At the euro zone summit in December 2018, the heads of state and government hit the brakes hard on the reform of fiscal governance: among the objectives assigned to the euro zone’s common budget that they are wishing for, the function of economic stabilization has disappeared. This is unfortunate, since this function is the weak point of the fiscal rules being pursued by the Member States.

In a recent article, we assessed how governments use the fiscal tools at their disposal to respond to information about trends in the public debt or the economic cycle that is at their disposal when they make their budgetary decisions. Thus, instead of evaluating the properties of fiscal rules using data that may well be revised retrospectively, we evaluated them “in real time”.[1]

Three main results emerged from our study. On the one hand, European governments ensure that their public debts are sustainable by improving their fiscal balance when the public debt increases. On the other hand, we found a trend towards fiscal consolidation at the bottom of the cycle in the euro area: fiscal policy is then rather destabilizing. Finally, euro area Member states have adopted a behaviour that was not found in the non-European countries in our sample: the euro zone Member states, unlike the others, continued to stabilize their public debts at the bottom of the cycle and during the crisis years. Thus the fiscal policy in the euro zone countries appears rather clearly to be untimely and inappropriate.

The results obtained as a whole for the euro area argue for a reform of Europe’s fiscal rules, but not necessarily in the sense most commonly accepted. The issue of stabilizing the public debt does not seem to be essential in so far as this is already being taken care of by the fiscal policies being implemented. Rather, what is needed is to rebalance these fiscal policies in favour of macroeconomic stabilization, especially if no common mechanism – such as a euro zone budget – has been set up for this purpose. European fiscal policies need to be more flexible and less prescriptive, with a focus on the dynamics of macroeconomic stabilization. Since no progress is envisaged at the European level, national automatic stabilizers need to be reinforced, increasing tax progressivity and the responsiveness of social spending to changes in economic activity in order to deal with the next cyclical downturn, both individually and collectively.

[1] One of if not the first article that focuses on evaluating fiscal policy using “real-time” data is by Golinelli and Momigliano (Journal of Policy Modeling, 2006). This literature is summarized in Cimadomo (Journal of Economic Surveys, 2016).

By Guillaume Sacriste, Paris 1-Sorbonne and Antoine Vauchez, CNRS and Paris 1-Sorbonne

In the latest article in La Revue de l’OFCE (no. 165, 2019), accessible here in French, the authors analyze the emergence of a new European government, that of the euro, built to a great extent on the margins of the EU’s existing framework. In noting this, the article takes stock of a process of the transformation of Europe (the European Union and Member States), which we call here the “Euro-isation of Europe”, in three dimensions: 1) the creation at its core of a powerful pole of Treasuries, central banks and national and European financial bureaucracies; 2) the consolidation of a European system of surveillance of the economic policies of the Member States; 3) the gradual re-hierarchisation of the political priorities and public policies of the European Union and the Member States around the priority given to financial stability, balanced budgets and structural reforms. The article thus makes it possible to redefine the nature of the “constraints” that the management of the single currency is imposing on the economies of the Member States, constraints that are less legal than socio-political, less external and overarching than pervasive and diffuse, and ultimately closely linked to the key position now occupied by the transnational network of financial bureaucracies in defining European issues and policies.

OFCE[1], ECLM[2], IMK[3], AKW[4]

It was during the climax of the so-called Eurozone sovereign debt crisis that we engaged into the independent Annual Growth Survey – the project was first discussed at the end of the year 2011 and the first report was published in November 2011. Our aim, in collaboration with the S&D group at the European Parliament, has been to challenge and question the European Commission contribution to the European Semester, and to push it toward a more realistic macroeconomic policy, that is to say less focused on the short term reduction of public debt and more aware of the social consequences of the crisis and the austerity bias. For 7 years, we argued against a brutal austerity failing to deliver public debt control, we warned against the catastrophic risk of deflation. We also alerted on the social consequences of the deadly combination of economic crisis, increased labor market flexibility and austerity on inequalities, especially at the lower part of the income distribution. We cannot claim to have changed alone the policies of the Union, but we acknowledge some influence, although insufficient and too late to prevent the scars let by the crisis.

Today, there is a need to take this initiative a major step forward. The adoption of the UNSDGs calls for a new approach to economic governance and to economic growth. The measurement of economic performance needs to evolve into the measurement of well-being on all three accounts of sustainable development – economic, social and environmental. A broad range of policies have to be mobilized coherently to this effect, which must move fiscal policy from a dominant to an enabling and supportive role. Moreover, those policies need to be anchored on a consistent and inclusive long-term strategy, and should be monitored closely to check that they deliver sustainability.

So far, the EU has not properly embraced this agenda, and the still prevailing European Semester process is an inadequate process to lead the EU towards achieving the UNSDGs. In the same way as the iAGS challenged the dominant orthodoxy in the macroeconomic field, the iASES 2019 – independent Annual Sustainable Economy Survey, the new name of the iAGS – is our contribution to support a strategy towards sustainability and show the way.

The iASES 2019 scrutinizes the general outlook of the EU economy. The coming slowdown largely results from the gradual attenuation of the post-Great Recession recovery momentum and the convergence of growth rates towards a lower potential growth path. The slowdown of growth coincides with a revival of political turmoil – Brexit, Italy’s public finances, the trade war and turbulences in some emerging countries. The upturn will come to an end at some point, and the euro area is not yet prepared for that, as imbalances persist and the institutional framework remains incomplete[5]. The euro area has moved into a large trade surplus, which may not be sustainable. Nominal convergence remains an important issue that should be addressed by political willingness to coordinate wage development more actively, beginning with surplus countries. Moreover, the incomplete adoption of a Banking Union may be insufficient to ensure banking stability in case of adverse shocks. The ECB could have to come to the rescue with extended unconventional policies, complemented with automatic stabilisation measures working across borders within EMU.

The social situation has slightly improved in the EU since the worse of the crisis and, on average, the unemployment rates across European countries are back at their pre-crisis levels. However, differences across countries and sections of the population are still huge. Policy makers need to be aware of possible trade-offs and synergies between economic, social and environmental goals in general and the Sustainable Development Goals (SDGs) in particular[6]. In line with the SDGs and intended goals of the European Pillar of Social rights iASES aims at promoting policies – expanding social investments, pro-active industrial policies, reducing working time, increasing collective bargaining to limit primary formation of inequalities – that address these goals and overcome the direct and indirect negative consequences of unemployment.

Climate change is arguably the most serious challenge that we collectively face. Computing carbon budgets can be useful to warn policy-makers about the effort to be delivered in order to put society on the road to environmental sustainability. The iASES evaluates the “climate debt” which is the amount of money that will have to be invested or paid by countries for them not to exceed their carbon budget, leading to three key policy insights. There are few years left for major European countries before exhausting their carbon budget under the +2°C target. Consequently, the carbon debt should be considered as one of the major issues of the decades to come since in the baseline scenario it represents about 50% of the EU GDP to stay below +2°C[7]. Framing the climate question in the words of debt is deliberate as the concept of excessive deficit applies today totally to the procrastination we demonstrate there.

[1] Directed by Xavier Timbeau with Guillaume Allègre, Christophe Blot, Jérôme Creel, Magali Dauvin, Bruno Ducoudré, Adeline Gueret, Lorenzo Kaaks, Paul Malliet, Hélène Périvier, Raul Sampognaro, Aurélien Saussay, Xavier Timbeau.

[2] Jon Nielsen, Andreas Gorud Christiansen.

[3] Peter Hohlfeld, Andrew Watt.

[4] Michael Ertl, Georg Feigl, Pia Kranawetter, Markus Marterbauer, Sepp Zuckerstätter.

[5] See « Some Challenges Ahead for the EU », OFCE Policy Brief, n°49, February 5,2019.

[6] See « Social Sustainability: From SDGs to Policies », OFCE Policy Brief, n° 50, February 5, 2019.

[7] See “An explorative evaluation of climate debt”, OFCE Policy Brief, n° 45, December 11, 2018.