The reason why the macroeconomic policy mix has been different on the two sides of the Atlantic in recent years remains a hotly debated issue. Was it due to a different reading of the root causes of the Global Crisis and, therefore, of the type of policy response considered most appropriate? Or was it instead the result of incomplete economic and financial integration in the Eurozone and the absence of a solid backstop for sovereign and banking sector problems, factors that led the Eurozone – as put by ECB’s President Mario Draghi – to resort to “policy choices made under the pressure of events and that were commendable by themselves, but that were sequenced in the wrong order”(Draghi 2014)? Or was it a combination of the two? Looking forward, will the policy mix continue to be different? Are the US and the Eurozone at risk of secular stagnation? What are the most effective fiscal consolidation plans for advanced economies with a high government debt/GDP ratio? What are the risks related to evolving liquidity conditions? And is there room for cooperation on the two sides of the Atlantic on macroprudential issues?
All these questions were raised and discussed at the recent “Macroeconomic Policy Mix in the Transatlantic Economy” workshop, jointly organised by the Centre for Economic Policy Research, the European Commission, and the Federal Reserve Bank of New York. The topics covered included secular stagnation, the output effects of fiscal consolidation, cross-border banking as a source and propagator of financial shocks, and the asset-market effects of unconventional monetary policies. In what follows, we provide a summary of the workshop’s discussion of these issues.
Summary of the discussions
Participants agreed that macroeconomic policy responses on both sides moved in the same direction in the first phase of the Global Crisis and were effective in avoiding a repetition of the Great Depression. The bifurcation took place in 2011 when the Eurozone, having failed to address early on its banking problems and confronted with the sovereign debt crisis, was caught in a negative feedback loop between bank credit risk and sovereign credit risk. The emergency measures that were adopted avoided the worst but resulted in pro-cyclical fiscal consolidation. Together with a credit crunch in a number of Eurozone countries, this led to a strong decline in demand, in general, and investment spending, in particular. In the same period, the US had to face challenges that also made its policy mix far from optimal, such as the abrupt fiscal consolidation in early 2013. Still, its macroeconomic stance was much less pro-cyclical and, helped by a healthier banking and financial sector, the US economy was able to stage a meaningful recovery and approach the point where monetary normalisation could start.
Some participants considered that the main factor behind the different performances of the US and the Eurozone was the reluctance to tackle decisively the Eurozone banking problems at the beginning of the Crisis. This failure gave rise to the negative feedback loop between banks and sovereigns that was the root cause of the double-dip recession in the Eurozone. Other participants, while agreeing that the Eurozone’s banking problems affected the policy sequence during the sovereign debt crisis, pointed out that the latter was significantly worsened by the excessively restrictive fiscal stance and the insufficient monetary accommodation, in particular in the 2011-12 period. The observation that credit problems in the Eurozone emerged only in 2012 helped support this view. Until that moment, credit growth had been stronger in the Eurozone than in the US.
Looking forward, some conference participants deemed the Eurozone to be more at risk of facing secular stagnation than the US. The Eurozone has excess saving, as indicated by its large current account surplus, depressed domestic demand, unfavourable demographics, very low productivity growth, and interest rates stuck at the zero lower bound. However, others argued that secular stagnation is not inevitable and suggested, in particular, that repairing The Eurozone bank balance sheets would be a step in the right direction. The asset quality review and the stress tests currently undertaken were considered pivotal in this respect.
Participants also noted that Draghi, in his keynote speech at Jackson Hole, identified three processes to restore growth in the Eurozone, namely:
- Delivery of structural reforms (both at national and Eurozone levels) to boost potential growth;
- Further monetary policy accommodation (possibly including the introduction of quantitative easing and broader outright purchases), whose positive effects would be felt through a currency depreciation and the provision of an insurance against deflationary risks; and
- Coordination of national fiscal stances to achieve a more growth-friendly overall stance for the Eurozone and to launch an ambitious investment programme to support growth.
Participants considered that such an array of measures would provide the best insurance compact against the risk of secular stagnation in the Eurozone.
In discussing cross-border banking, participants noted that the ways that financial conditions were buffeted by winds generated abroad reinforced the importance of governments having financial tools to cope with international shocks. Both ex-ante measures and ex-post policies – the use of swap lines, the introduction of liquidity requirements, and, more generally, the implementation of Basel III reforms – were seen as important mechanisms to moderate the effects of a large global liquidity event, in addition to the more conventional lender-of-last-resort actions.
In terms of transatlantic policy cooperation, participants highlighted three potential dimensions:
Trade liberalisation, including the successful completion of the Transatlantic Trade and Investment Partnership, which would help raise productivity growth and lift living standards;
- Regulatory policy convergence and mutual recognition in the financial sector; and
- Internalisation by central banks of each other’s actions and communication management so as to minimise negative spillovers.
Some observed that, going forward, the likely asymmetries in exit strategies from the zero lower bound may lead to some challenges for monetary policy in the transatlantic economy, including (but not limited to) exchange rate developments.
Disclaimer: The views summarised in this post represent those of the conference speakers and not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors.
Draghi M (2014), “A consistent strategy for a sustained recovery”, Lecture at Sciences Po, Paris, 25 March,
Draghi, M (2014), “Unemployment in the euro area”, Speech at the Annual central bank symposium in Jackson Hole, 22 August,