[Comparative reflections on the underpinnings of monetary policy]
Financial Times; Nov 15, 2002
COMMENT & ANALYSIS: Germany must go on a shopping trip
By John Plender
The world is overdependent on the English-speaking countries, especially the US, as a source of demand in the global economy. No one expects Japan to do much for global demand for quite some time. Continental Europe ought to be in a position to save the world from recession or deflation if the Anglophone bloc prematurely unwinds imbalances that have caused private sector debt to soar and current account deficits to widen. But we all know that is unlikely to happen.
The familiar snag is that the eurozone's fiscal policy is hobbled by a stability and growth pact that Romano Prodi, president of the European Commission, has rightly dubbed "stupid". Meanwhile, the other standard policy prescriptions look ill-suited to the task.
The obvious cyclical remedy for the ills of Europe's slower-growing economies is a cut in the European Central Bank's short-term interest rate. The structural medicine favoured by most liberal economists in investment banks is the deregulation of rigid labour markets.
Yet in Germany, where the threat of deflation is greatest, the long maturity of debt, especially in the housing market, means monetary policy imparts less stimulus than in the US or UK. Comparable strictures apply in France and Italy. And loosening labour markets might be counterproductive in a downturn. Employers facing a credit crunch and a profits squeeze would be more inclined to fire than to hire, worsening the demand problem.
The reality is that in the eurozone monetary policy works very differently from in the Anglo bloc, a point that is reflected in contrasting structures of savings and debt. In 2001, according to the Organisation for Economic Co-operation and Development's Economic Outlook, household savings as a percentage of disposable income in Germany were 10.2 per cent; in France 15.8 per cent; and in Italy 10.9 per cent. The figures for the US and the UK were 1.6 per cent and 5.6 per cent.
The same contrast is apparent in these countries' household liabilities. The Bundesbank calculates that, after adjusting for transatlantic differences in the statistical treatment of sole proprietorships and partnerships, household liabilities as a percentage of national output amounted to 108 per cent in the US, 80 per cent in the UK, 74 per cent in Germany, 46 per cent in France and 30 per cent in Italy.
In confronting the aftermath of a burst stock market bubble, US monetary policy has worked effectively and with a relatively short lag via its impact on the housing market. The Federal Reserve's successive cuts in interest rates have encouraged households to refinance mortgages, withdraw equity from homes and spend to off-set the negative wealth effect from the falling stock market.
In the UK the process is less slick because more home loans are at floating rates and there is less securitisation. And, if anything, monetary policy has worked too effectively via the housing market, leaving UK policymakers with the conundrum of how to deal with a housing bubble without throttling the corporate sector.
In continental Europe, in contrast, there is less home ownership for monetary policy to work on, as well as a plethora of constraints on home loans and consumer credit imposed by law, market structures and culture. In the German housing market, for example, loan to value ratios are stringent relative to the UK's. People have to save in order to buy and most home loans are for housing construction, not purchases of existing housing stock.
Usury laws in the eurozone often impose low ceilings on interest rates, which makes it harder for banks to adopt a portfolio approach to consumer credit that permits a high level of bad debts. In many countries part of the cost of credit card fraud falls on the card-holder, unlike in the US and the UK, thus ensuring that marketing literature for new plastic cards is not constantly falling on to doormats.
The high saving, low borrowing ethos makes for stability. Yet this stability is not much help when an economy is threatened with deflation. And in Germany and Italy, demographic pressure will worsen the threat by shrinking the working age population.
How curious, then, that so much of the debate about liberalisation in continental Europe is fixated on labour markets and so little concerned with housing and credit. In current circumstances it would surely be in the interests of the harder-pressed eurozone economies to cheer themselves up and generate more growth by removing many of these constraints on borrowing and spending. In terms of the private sector debt position, there is plenty of headroom. The politics would be far less tricky than in tackling labour market rigidities. And the risk that this would generate UK-style housing bubbles is pretty remote.
The greater danger is that the US and European economic cycles would become more synchronised and thus less stable. But if the risk of deflation is serious, that is a problem to worry about when it comes.