The world’s savings and investments are imbalanced. While some countries persistently borrow over time, others act like bankers to the world – lending year in and year out. This column argues that these imbalances matter for asset pricing in financial markets, and are key to understanding excess returns in currency markets.
The unprecedented inflow of refugees to Europe and their uneven distribution calls for coordinated policy actions. This column discusses the economic challenges of the refugee influx. The fiscal and growth impacts largely depend on the speed and success of labour market integration. It is important therefore to implement a range of policies that can foster refugees’ economic integration.
Current office-holders often seem to be re-elected quite easily, irrespective of their performance. This ‘incumbency advantage’ make it harder for first-time candidates and undermines democratic competition. This column proposes a new rule for re-election – the score-replication rule. In its simplest form, such a rule would require incumbents to obtain a percentage of votes at least as high as their highest historical election performance. This would restrain the negative incumbency advantage and potentially reduce policy polarisation.
Cross-country differences in productivity have been of long-standing interest to economists. This column digs a little deeper, looking into differing managerial quality between different nations. In high-income countries, the mean earnings of managers tend to grow faster than for non-managers and the earnings growth of managers relative to non-managers corresponds to output per worker. To understand why countries like Italy lag behind the US in terms of output per worker, we should take into account that there are more incentives to invest in managerial skills in the US.
As doubts grow about the effectiveness of quantitative easing, monetary policymakers are leaning towards cutting interest rates further into negative territory as their preferred mode of easing. But this begs crucial and untested questions of whether banks will be willing to pass on the cost to their retail depositors, and of how depositors might react if they did so. This column notes a recently published survey in which a large majority of respondents said that they would withdraw their savings, and yet few would spend more. Although it could be argued that savers might react less negatively when confronted with the reality of negative rates, their powerful aversion to the prospect raises troubling questions about the potential effectiveness of this policy tool.
A combination of shocks has led to the spectre of a renewed systemic bank crisis within the EU. This column argues that what is needed is a regulatory policy response in the form of joint action by European governments to convince financial investors that bank liabilities are secure.
Sterling fell dramatically following the announcement of a date for the UK’s referendum on whether to remain an EU member. This column reports the views of leading experts on whether the possibility of ‘Brexit’ would lead to further volatility in financial markets and the broader economy. There is near unanimity in the monthly Centre for Macroeconomics survey that the Brexit question will increase financial volatility and will pose economic costs in the medium term. Financial volatility can be expected to be especially high if polls remain close. Lack of clarity about the UK’s economic arrangements with the EU following Brexit are the main concern for the medium term.
Since the Global Crisis, a key ingredient of reforms has been to force over-the-counter contracts to be traded in more transparent exchange-like settings. The aim has been to reduce the cost of trading such instruments and make markets more resilient. This column analyses the impact of the Dodd-Frank Act in the US on the market for vanilla interest rate swaps. The introduction of swap execution facilities trading is associated with a significant improvement in swap market liquidity. This suggests that Europe may see similar benefits from centralising swap trading, though it remains to be seen how these markets will operate in more volatile times.
The Kuznets curve was widely used to describe the relationship between growth and inequality over the second half of the 20th century, but it has fallen out of favour in recent decades. This column suggests that the current upswing in inequality can be viewed as a second Kuznets curve. It is driven, like the first, by technological progress, inter-sectoral reallocation of labour, globalisation, and policy. The author argues that the US has still not reached the peak of inequality in this second Kuznets wave of the modern era.
By the end of 2013, growth in Latin America had begun to decelerate. The ensuing policy responses to this have differed across countries. This column uses data from the past 40 years to analyse policy responses to economic distress in the region. On average, countercyclical policy responses to crises have been more common over the last 15 years than previously. Latin America thus appears to have graduated in terms of monetary and fiscal responses to crises. But there is still a great deal of heterogeneity across countries in the region, and they must continue to build sound and credible fiscal and monetary institutions.
There is a broad consensus that banks and insurance companies may contribute to systemic risk in the financial system. For other financial market institutions, it is less clear-cut. This column examines the resilience of pension funds to severe shocks. While the evidence indicates that they are of low systematic importance, policy trends that apply to all financial players may undermine this. Specifically, risk-based solvency requirements carry the risk of homogenising the behaviour of all players, potentially amplifying shocks and destabilising markets.
Recent data releases related to the Eurozone have been disappointing. This column argues that momentum from the long-delayed 2014-15 recovery is faltering because the Eurozone economy is affected, with a lag, by the US slowdown. The traditional, lagged relationship between the EZ and US business cycles – which disappeared in the aftermath of the Global Crisis – is now reasserting itself.
The recent dramatic decline in the price of oil runs counter to the argument that oil prices should be high because of the high costs. This column presents new evidence on this relationship. Using a representative global dataset, the authors find that upstream costs follow oil prices with a time lag. In particular, a sustained 10% increase in the price of oil leads to an increase in upstream activity of about 4%, and in this way triggers a sustained 3% increase in global upstream costs after a lag of one to two years.
A common theme of recent trade theory models is that globalisation-related shocks induce worker sorting across industries, labour markets, and plants. However, there is little empirical evidence of shocks causing such endogenous mobility responses. This column explores how rising international trade exposure affected the job biographies and earnings profiles of German manufacturing workers since the fall of the Berlin Wall. Individuals are found to systematically adjust to globalisation, with a notable asymmetry in the individual labour market responses to positive and negative shocks. Critically, the push effects out of import-competing manufacturing industries are not mirrored by comparable pull effects into export-oriented branches.
For the past few decades, the growth of industrialised economies has been remarkably balanced. This column suggests that such balanced growth results from schooling levels increasing over time. When capital and schooling are sufficiently complementary, increases in schooling offset the effect of capital deepening on the capital share and ensure that growth remains balanced.
The ECB’s response to the Crisis – not providing stimulus to the Eurozone economy when it needed it, and allowing it to slip into a low inflation trap – is a reflection of the monetary union’s faulty architecture. This column recalls a 1998 manifesto from several distinguished scholars that warned EZ policymakers of the potential consequences of a misguided policy framework. Two sets of issues need to be critically addressed by current EZ policymakers: its objectives and instruments.
A move is afoot to eliminate high denomination bills such as the €500 note. This column argues that the elimination would not, on its own, stem the flow of funds to support terrorism, but it is a necessary step on the road to restricting terrorist finance. While there are counter-arguments, they tend to argue for activities that involve breaking the law – in one way or another.
Prior to the Global Crisis, banks could easily use off-balance sheet structures to lower their effective capitalisation rates. This column examines another way that US banks circumvented capital regulations – by maintaining minority-owned, non-consolidated subsidiaries. Had these subsidiaries been consolidated, average reported equity-to-assets ratios would have been 3.5% lower. These findings suggest that some US banks were actively misrepresenting the riskiness of their assets prior to the crisis.
How should the international community deal with the solvency crisis of a systemic country? This column argues that the presence of spillovers calls for reducing bail-ins, while requiring somewhat greater fiscal adjustment by the crisis country. To avoid excessive fiscal consolidation, the international community should also provide highly systemic countries with official transfers. To contain moral hazard, it is important to use transfers only when spillovers are particularly severe.
A synchronous growth slowdown has hit emerging markets, especially the BRICS, since 2010, with the potential for significant adverse spillovers to the rest of the world. This column estimates that a 1 percentage point decline in BRICS growth could reduce global growth by 0.4 percentage points, and growth in other emerging markets by 0.8 percentage points, over the following two years.
A series of mega-regional free trade agreements are currently being negotiated. This column argues that Japan is in a unique position to be able to negotiate with due regard for consistency among these agreements. It should thus seek to bring negotiations to a successful end and to expand and integrate the mega-regional FTAs. This will help rebuild the world trade regime so as to pave the way for achieving economic growth for the entire world.
One of the legacies of the Global Crisis is a high ratio of public debt to GDP. While current levels may be sustainable, another series of bad shocks could easily tip the balance and lead to unsustainable debt ratios. This column argues that against this background, growth-indexed bonds can help. By decreasing payments when growth is low, they can substantially reduce the upper tail of the distribution of the debt ratio and lessen the risk of a debt explosion.
Much stronger capital buffers are fundamental to banking reform. But seven years on from the Global Crisis, the question of how much stronger has not been fully decided. This column reviews the Bank of England’s recently published framework for the systemic risk buffer. It is suggested that the Bank should go further than it proposes, and require stronger capital buffers for systemically-important retail banks.
The bloody conflicts in Syria and Iraq have forced the issue of refugees onto the global agenda. However, among the neglected aspects of this discussion are how governance can be restored to conflict regions and the welfare effects that such actions, which are likely to be coercive, will have on local residents. This column examines the impact of a counter-insurgency programme in the Philippines on one development outcome in contested territories – malnutrition of young children. The programme saw a substantial long-term decrease in malnutrition in recaptured areas, but a rise in malnutrition in neighbouring areas. Such efforts may simply displace insurgents and their negative effects, rather than reducing them.
One thing economists can agree on is that inflation is hard to forecast. This column argues that in this context, the idea that ‘core inflation’ may be a useful predictor is very appealing, especially for central banks that need to know where inflation is heading. Evaluating the ability of core to forecast headline inflation for OECD and some non-OECD countries, it seems that sizable predictability emerges for a very small subset of countries, but it is either subtle or undetectable for most other economies.
There are some risks that households cannot insure against or avoid. These are often called ‘background risks’, with the most prominent being labour income risk. In this column, the authors revisit the importance of background risk for portfolio allocation. Addressing some limitations in the current literature, they find that the marginal effect of background risk is much larger than previously thought. Overall, the economic importance of human capital risk crucially hinges on the insurance role of the firm and the amount of assets available to the individual to buffer labour income shocks.
It has been claimed that recessions as a result of a financial crisis tend to last longer than normal recessions. This column asks whether early intervention to help distressed banks during financial crises is effective in mitigating the consequences of financial distress. The evidence suggests that decisive and early recapitalisation of banks can shorten recessions by several years and help speed up recovery.
Since the beginning of the Global Crisis, the ECB has faced a sequence of problems. This column discusses some of these problems. It also highlights the successful first reaction of the ECB to the crisis and its adequate monetary policies. There are still unresolved structural problems in the Eurozone, however. Among them are the lack of a proper banking union and the need for a better fiscal policy coordination. And the job for such a change within the Eurozone cannot be delegated to the ECB.
When the newly elected Greek government of George Papandreou revealed that its predecessor had doctored the books, financial markets reacted violently. This column discusses the steps implemented by policymakers following this episode, which were essential in resolving the Crisis. What is remarkable, in hindsight, is the combination of pragmatism and reasoning based on sound economic principles displayed by European leaders. Instead of finger pointing, they acknowledged that they were collectively responsible for the Crisis.
The role of equities in Europe’s capital markets has diminished since the Global Crisis and is only slowly recovering to its prior level. This column argues that revitalising its equity markets has much to offer Europe in terms of funding business growth, creating jobs, and delivering long-term pension returns for the ageing population. The root causes of Europe’s underutilised equity markets are both cultural and regulatory. Understanding and addressing these barriers are the next necessary steps towards the full utilisation of equities.
The Eurozone Crisis has abated but the question about the future of the euro remains on the agenda. This column discusses some of the design failure of the Eurozone and their possible solutions. The Eurozone in its current state is not an optimal currency area and is fragile. Ideally, a stabilisation fund and a budgetary union should be set up. Since this is politically unobtainable right now, small steps should be implemented to create some fiscal space at the level of the Eurozone, and to start with a limited programme of debt consolidation.
James Tobin’s classic ‘funnel’ theory questioned how best to calibrate the overall stance of macroeconomic policy in an economic region. This column revisits key questions that emerged out of the EZ crisis through the lens of Tobin’s theory. A key insight is that monetary policy cannot achieve stabilisation objectives without stronger mechanisms for fiscal burden-sharing and risk-pooling. Although short-run solutions are possible under the existing circumstances, long-run stability will require a policy mix that convincingly deals with the issue of fiscal risk-sharing.
The boom-bust cycle in the Eurozone between 2000 and 2008 is essentially a story of cyclical asymmetries between the Core and the Periphery. While stressing the importance of addressing these asymmetries – especially via fiscal policy – the ECB has failed to take them explicitly into account in its own policy-setting. This essay argues that these asymmetries may persist precisely because they are not a central target of stabilisation policy – both fiscal and monetary.
As a monetary union based on a single currency, the Eurozone is supposed to be immune from problems characteristic to fixed-exchange rate regimes. This column argues that this is not the case. The Eurozone still faces some adjustment problems. It seems unable to generate sufficient growth and inflation to place excessive public debt on a credible reduction path. It does not have a functioning adjustment mechanism to reabsorb existing competitive imbalances. In the long run, the Eurozone should aim to achieve a full integration of labour and capital markets. This is only feasible with budgetary and structural reforms in its member states.
Institutional redesign and reform are currently being debated and implemented at the EU and EZ levels. However, there is a growing institutional gap across member countries – especially between the core and periphery. This column illustrates the extent of this gap. Weak institutions have already stifled reform efforts, such as the Economic Adjustment Programs undertaken by Greece and Portugal. The success of pan-European reforms and the future of the Eurozone will require coordinated action to close this institutional gap.
The Eurozone is more crisis-prone than other major currency areas. This column suggests that due to its hybrid structure, the EZ is likely to remain crisis-prone in the near future. A main challenge is the specific insolvency risk to which the member states are exposed, which in the longer term it can only be eliminated by some form of debt mutualisation. Another challenge is that the EZ suffers from an insufficient coordination of fiscal policies and wage trends.
Misalignments of real exchange rates continue to be the most visible and painful symptom of asymmetric shocks within the Eurozone. An important factor behind such misalignment is the difference in national wage formation and bargaining systems, especially between core and periphery members. This column argues that all members need to have institutions that ensure wage developments are in line with productivity developments. This would eliminate an important source of asymmetric behaviour and reduce resistance to EZ-wide fiscal mechanisms capable of absorbing asymmetric shocks.
There are certain conditions needed to make a common currency across diverse economies a success and the Eurozone is clearly not satisfying them. This column argues that institutions and policies in place six years after the debt crisis have mitigated the risks of another Great Recession. But they have not done enough to alleviate the need for fiscal transfers in the future. We need ever-closer fiscal cooperation, with some caveats.
The ongoing Eurozone Crisis has raised many debates on what needs to be done to reduce the frequency and severity of similar future crises. This column discusses the implications of equity versus debt flows in terms of risk sharing during the Crisis, and in terms of slow recovery in the aftermath of the Crisis. The author suggests that to induce a fast recovery in an aftermath of a crisis, the EZ needs a banking union and a broader financial union based on equity ownership.
The Eurozone’s ‘Banking Union’ created a system of banking supervision and a common institution to restructure troubled banks. There remain two issues, however, that need to be addressed: banks are holding too much debt of their own sovereign, and deposit insurance is only backstopped at the national level. This column argues that these issues need to be addressed simultaneously for economic and political reasons. Specifically, periphery and core countries hold opposing positions on remedies to the respective problems. A combination of the two makes economic sense and could represent an acceptable political compromise.
Not everybody agrees that the Greek crisis means the EU needs more integration. This column, from the German Council of Economic Experts, argues that for as long as EZ members are unwilling to transfer national sovereignty over economic and financial policy to the European level, all reform proposals must withstand a critical evaluation of the incentives they set for national economic and financial policy. The institutional framework of the single currency area can only ensure stability if it follows the principle of that liability and control must go hand in hand. Those who decide must bear the consequences of their decisions.
Important progress has been made in repairing the design faults that the EZ Crisis revealed. This column introduces a new VoxEU eBook which argues that fixing the Eurozone is a job half done. The eBook, which presents 18 chapters by leading economists that hail from a broad range of nations and schools of thought, is surely the most comprehensive collection of solutions that has ever been assembled.
A major challenge for monetary policy is predicting how exchange rate movements will impact inflation. This column explains why rules of thumb could be misleading and proposes a new approach that incorporates the source of exchange rate movements when evaluating how they pass through to import prices and inflation.
The business cycles of countries with greater bilateral trade and multinational production linkages are more closely correlated. But the meaning of this empirical relationship is not well understood. Some contend that these linkages allow for the transmission of shocks across countries, while others argue that countries that trade more with each other are similar in other ways and are thus subject to common shocks. Using data from France, this column examines the properties of international co-movement at the firm level. Even after controlling for common shocks, there is still substantial evidence of transmission of shocks through trade and multinational linkages. Furthermore, trade linkages matter more than multinational ones, especially when it comes to the aggregate impact.
Ethnic divisions have been shown to adversely affect economic performance and political stability, particularly in Africa. However, the underlying mechanisms remain poorly understood. Using experimental data from Kenya, this column studies whether one potential mechanism – co-ethnic bias – affects altruism. Strikingly, most tests yield no evidence of co-ethnic bias, suggesting that other mechanisms must be driving the negative association between ethnic diversity and economic and political outcomes in Africa.
Macroprudential policies are meant to reduce procyclicality in financial markets and associated systemic risks. However, empirical evidence on which policies are most effective is still preliminary and inconclusive. This column documents the use of macroprudential policies by a large set of countries over an extended period, and covering many instruments. It shows which policies are most effective in reducing the growth rates of overall credit and household and corporate sector credit, and explores differences across countries, degrees of avoidance, and whether policies work better during booms or busts.
The Global Crisis was a watershed, not just for economies around the world, but for economics as a discipline. This column introduces a special issue of Economic Policy that collects key papers on the Global Crisis published in its aftermath between 2009 and 2014. The papers chart the evolution of economists’ thinking on the causes of and cures for the Global and EZ Crises.
Many countries exempt foreign-sourced income from taxation at home, with income taxed only in the source country. In 2009, the UK moved from a system of tax credit to a system of tax exemption of foreign-earned income of firms. This column looks at the effects of this reform on firm behaviour. Immediately following the reform, firms were induced to pay significantly more dividends to the UK and decreased their investments. But neither effect persisted in the long run.
With the rise of global value chains, trade in intermediates now accounts for more than two-thirds of total trade. This column provides evidence that trade in parts and components of capital goods between new and old EU countries is driven by wage differences across countries. It further shows that wage differences play an important role in the ex ante investment decision to establish a new production network.
Expectations play a key role in assessing how oil price fluctuations affect the economy. This column explores how consumers, policymakers, financial market participants, and economists form expectations about the price of crude oil, the differences in these expectations, and why future realisations of the price of oil so often differ substantially from these expectations. Differences in oil price expectations are shown to matter for quantifying oil price shocks and their transmission.
Digital technologies are having dramatic impacts on consumers, businesses, and markets. These developments have reignited the debate over the definition and measurement of common economic statistics such as GDP. This column examines the measurement challenges posed by digital innovation on the economic landscape. It shows how existing approaches are unable to capture certain elements of the consumer surplus created by digital innovation. It further demonstrates how they can misrepresent market-level shifts, leading to false assessments of production and growth.
There is no consensus on the effects of agglomeration on innovation. This column presents new evidence on how knowledge turnover impacts the quality of innovation. Agglomerated regions with active knowledge turnover, as measured by interregional migration of university graduates, tend to have a higher number of patent citations, the metric used for quality of innovation. Cluster policy aimed at active innovation may not be effective if interregional migration of knowledge workers is inactive.
The benefits of microfinance are in the details. This column takes a look at commercial bank lending to Indian self-help groups – smaller, informal community-based groups – as a new and successful microfinance initiative. Different ways of thinking about getting credit to the poorest and most marginalised in society can work, but only if the institutions are properly geared up for their customers.
Parallels are often drawn between the Great Recession of the past decade and the economic turmoil of the interwar period. In terms of global trade, these comparisons are based on obsolete and incomplete data. This column re-estimates world trade since the beginning of the 19th century using a new database. The effect of the Great Recession on trade growth is sizeable but fairly small compared with the joint effect of the two world wars and the Great Depression. However, the effects will become more and more comparable if the current trade stagnation continues.
There are good reasons to think that social networks can reduce barriers to the exchange of production factors. Using data from 51 villages in Gambia, this column examines whether transfers of land between rural households improve efficiency, and whether social networks help or hinder such transfers. The results suggest that social ties may indeed be able to offset the negative impact of a limited or non-existing institutional framework.
Offshoring and global value chains have reshaped global trade patterns. This column describes how the German economy has been exposed to significant offshoring for at least three decades. The authors find an increasing importance of high-end tasks in the country. Organising and consulting activities under deadlines, changing business conditions, and tougher performance standards are an increasingly common reality in German workplaces. Labour market institutions in German trade partners are largely unrelated to the changing content of German imports.
The increase in the debt of emerging market non-financial firms has been large. This column argues that to understand the risks, if any, it is important to know the state of corporate balance sheets and what firms have actually been doing. In some cases external debt has been issued to substitute more expensive local debt, in others to finance real investment, and in several countries it has been used to exploit carry trade opportunities. In virtually all cases, however, good information on corporate currency mismatches is hard to obtain. There needs to be better information and better reporting if we are to make headway.
The Great Depression is considered one of the darkest times for the US economy, but some argue that the US economy experienced strong productivity growth over the period. This column reassesses this performance using improved measures of total factor productivity that allow for comparisons of productivity growth in the Depression era and in later decades. Contrary to Alvin Hansen’s gloomy prognosis of secular stagnation, the US economy was in a very strong position during the 1930s by today’s standards.
China’s diminished growth prospects are in the news and seem to spell bad news for just about everybody. This column assesses the evidence, arguing that China’s economic growth will be much slower from now on, reducing international trade. Perhaps the biggest challenge for China will be future political tensions in reconciling economic dreams with economic realities.
Many governments are committed to promoting the roll-out of fibre optic broadband networks. Little is known, however, about the economic value of these investments. Using house prices to infer the value of high-speed internet access, this column discusses the impact of fibre optic broadband in England. A fast broadband connection is found to increase house prices sufficiently in urban areas to pass a cost-benefit test, but the case for universal delivery in rural areas is not as strong. And even in areas where people are willing to pay for a faster connection, internet providers may be unwilling to deliver it only to see house-sellers appropriate the rent from their investments.
The 2015 Nairobi WTO Ministerial unshackled governments from the deadlocked Doha Development Agenda and opened the door for new issues and new approaches. The Ministerial Declaration calls on new initiatives to be agreed by consensus. This column argues that WTO procedures permit ‘clubs’ of countries to agree on additional policy disciplines if the benefits extend on a non-discriminatory basis to all WTO members. Consensus is not needed for such clubs.
In addition to setting interest rates, central banks also communicate with the public about economic conditions and future actions. While it has been established that communication can drive expectations, less is known about how it does so. This column attempts to shed light on this question. Applying novel measures to the content of Federal Reserve statements, it shows that forward guidance is a more important driver of market variables than disclosure of information about economic conditions.
Most lending by banks to corporations occurs through loans with floating interest rates. As a result, conventional monetary policy actions are transmitted directly to borrowers via a change in the interest rate paid on existing bank loans. This column argues that the ‘pass-through’ of policy rates to the cost of outstanding bank loans has significant real effects for corporations.
Immigration is an important election issue that often benefits right-wing political parties. Contemporary European politics is an example par excellence. Immigration in the US has been intermittently at the fringes and centre-stage in recent years, and this column looks at the extent to which US voters care about immigration. The political effect of immigration turns out to crucially depend on the extent to which immigrants participate in the political process. One thing from the research is clear: Republicans are generally opposed to immigration reforms, especially if they include a path to citizenship for currently undocumented immigrants. Naturalised immigrants are a liability for conservative politicians, as they tend to vote for progressive parties.
The World Bank has identified 37 countries as being in a ‘middle-income trap’, but few formal tests of the middle-income trap hypothesis exist. This column presents a new test based on a more nuanced observation that incorporates information on a country’s long-run growth path. Only seven out of 46 middle-income countries are found to be potentially ‘trapped’. Some countries that are usually considered to be trapped may just be growing very slowly.
Why is growth in Europe so low? Among the contributing factors, this column highlights the role of financial structure. Intermediation in Europe is heavily bank-based, and the authors' novel empirical findings indicate that such a structure exerts a negative effect on long-run economic growth and exacerbates its response to sharp drops in real estate prices. The findings support policymakers’ efforts to rebalance financial structure towards securities markets.