December 7, 2011
Mr. Mayer, the European debt crisis is keeping the financial markets firmly in its grip. Rating agencies are tightening their focus on more and more countries – lately even France. How do you explain the markets’ shift away from the high level of debt tolerance usually seen in the past towards a high level of debt intolerance now?
The high debt tolerance of the past was based on an erroneous assessment of credit risks. In the private sector people thought the risks could be calculated precisely and they relied on models that were based on the complete rationality of economic actors and efficiency of the markets. Since these two assumptions are not always borne out, these models delivered flawed risk metrics. In the euro area it was assumed that a country could not go bankrupt, and people overlooked the very limited willingness of the countries to accept mutual liability. If Article 125 of the EU Treaties, the ban on bail-outs, had been taken seriously, more caution would have been exercised in granting loans to countries in the euro area.
You have proposed that the ECB buy up (Italian) sovereign debt at a fixed maximum interest rate – in unlimited quantities if necessary. What do you hope this will achieve?
The Italian government (under Mario Monti) and the Spanish government (under Mariano Rajoy) seem determined to restore the health of their public finances and reform economic policy. But this will only succeed if the financial conditions in those countries are not so restrictive that their economies are choked to death. If their monetary conditions are to be relaxed, it will not suffice for the ECB to merely lower the refi rate. Capital market rates must also come down, and to accomplish this the ECB ought to cap sovereign bond yields by intervening in the market.
Wouldn’t this mean the ECB would gamble away its most valued asset, its independence?
No. After all, it’s not a matter of funding ailing public budgets, but establishing the monetary conditions needed to restructure the public budgets in the first place.
If nothing else, this would be the final departure from the policy that used to be pursued by the Bundesbank. How could politicians in Germany sell such a course of action to the nation?
In Germany, the tendency is to nail down a regulatory framework for the economy and then reject any other measure that doesn't fit this framework yet is temporarily necessary to achieve the desired objective. Economists call this “dynamic inconsistency”. To avoid this inconsistency officials should insist that in the targeted final scenario the ECB refrain from buying sovereign bonds in the secondary market, yet allow the ECB to intervene there temporarily in order to ease monetary conditions. In other words, the ECB should secure the initial funding for the reform programmes, but not get involved in permanent funding.
What sort of influence would such ECB intervention have on the inflation rate in the euro area?
None, as long as the ECB confined its activities to initial funding.
Eurobonds – i.e. the assumption of joint and several liability by all the euro member countries for their sovereign debt – are cited as another possible solution for restoring the confidence of the capital markets. What do you think of this option?
If eurobonds are an option at the beginning of the adjustment process, they make it superfluous and pave the way to a transfer union. If, by contrast, they are an option at the end of the adjustment process, they may be a very sensible way of creating a large and liquid market for eurozone government bonds. Besides, it ought to be recalled that eurobonds, once introduced, can scarcely be abolished again. This means if they are launched prematurely there is a serious risk of a transfer union materialising. In contrast, the ECB’s purchases of government debt, that is the initial funding for the reform programmes, can be called off by the Governing Council at any time if these purchases appear to be turning into a permanent funding vehicle.
Let’s take a look at the United States: government debt there has also skyrocketed over the past few years. And so far US policymakers have not yet managed to launch appropriate countermeasures to deal with the problem. What would you say are the odds of the US being able to consolidate its public budgets?
They are not very good, unfortunately. The political stalemate in the US will prevent rigorous consolidation of that country’s public finances before the next elections.
How is it possible to fundamentally stop the growth of mountains of debt in Western democracies given widespread public resistance to austerity measures?
People must come to realise that piling up further mountains of debt incurs costs that will have to be shouldered by future generations who will have to service the debt via their taxes. But if Germany can resolve its exit from nuclear power, why shouldn’t it also be able to reach a decision to exit from government debt?
What impact will the debt crisis have on GDP growth in Germany, Europe, the US and the emerging markets? Is a new recession in the offing?
Since the process of running down debt, so-called de-leveraging, does not take place at a uniform pace but rather in fits and starts, economic performance is much less stable now than it used to be. Each new de-leveraging step goes hand in hand with a weakening of business activity. At the same time, the de-leveraging process has the effect of reducing trend growth to a much lower rate than before. This can be compared with a low-flying airplane that repeatedly slips into air pockets. Since we in the eurozone are now in the throes of a pretty strong bout of market-induced de-leveraging, the economy is set to fall into recession in 2012 and contract by 0.5%; in the event, Germany still stands to perform relatively well with “borderline growth”. In the US, by contrast, the pace of private-sector de-leveraging is continuing to decrease, so GDP growth there is likely to hit 2.3%. Unlike in the industrial countries, growth in the emerging markets will probably remain very robust at roughly 6%, so the global economy is poised to expand by around 3.5%.
Dr. Thomas Mayer is Chief Economist of Deutsche Bank Group and Managing Director of Deutsche Bank Research.
Thomas Mayer (+49) 69 910-30800