“The Transatlantic Economy Ten Years after the Crisis: Macro-Financial Scenarios and Policy Response,” was the focus of a conference jointly organised by the New York Fed, the European Commission, and CEPR in April 2018. These three institutions had previously collaborated on a series of events related to transatlantic economic relations, including a workshop in April 2014 and a conference in April 2016. Ten years after the global financial crisis, this conference came at a crucial time in the history of the relationship between the US and the EU, and provided an opportunity to revisit and assess recent policy responses. A number of questions were addressed by the panellists: Is the world economy back on a sustainable growth path or have we entered a secular stagnation era with persistently low interest rates and inflation? How large are the spillovers of monetary and fiscal policies? Have we done enough to maintain financial stability and deal with cross-border resolution issues, which have been one of the most vexing topics in the regulatory space?
In his keynote address, the Chair of the Council of Economic Advisors (CEA), Kevin Hassett, discussed the empirics of tax policy in the context of the recently enacted large tax cut in the US. He emphasised that in the recent econometric literature, when an effort is made to control for endogeneity problems, tax effects are estimated to be larger than previous estimates using standard macroeconometric methods (this conclusion was challenged in the Q&A session by some participants). According to Hassett, this would be in line with the recent positive revisions of the forecasts for US GDP growth. In fact, consensus forecasts for US growth in 2018 and 2019 were projected to be around 2.3% and 2.1%, respectively, as of November 2017, but they had been recently revised upward to 2.8% and 2.3%.
Hassett also mentioned that some ongoing work at the CEA using a vector autoregression approach to estimate the spillover effects of the US tax expansion on the rest of the world had found large positive effects. He argued that US tax policy, far from creating more inequality, would actually decrease inequality by leading to raises in wages and creating more manufacturing jobs.
The European Commission Vice-President Valdis Dombrovskisdelivered the second keynote address. He pointed out that Europe has learned the hard way that a crisis on the scale of the global financial turmoil cannot be dealt with at the national level alone. As a result, the euro area had put in place crucial reforms to improve its ability to prevent and respond to shocks, namely, the creation of the European Stability Mechanism, the introduction of a single rulebook for banks, the set-up of a banking union and a capital market union, and the strengthening of EU-level frameworks for economic and fiscal governance and surveillance.
Because of these actions – supported by effective monetary policy and structural reforms at the national level – the euro area had recovered and in 2017 it grew at its fastest rate in a decade. However, further progress was needed to complete the banking union and the capital market union, and to strengthen macroeconomic stabilisation tools at the euro area level. The current economic tailwinds provide the euro area with a window of opportunity to deepen the Economic and Monetary Union, and the euro area could not and should not wait for another crisis to move forward. Finally, looking at the future of the transatlantic relationships, Vice-President Dombrovskis called for international leadership that could ensure a rules-based order and a level playing field for the global economy.
During three sessions, conference participants discussed the strength of current growth prospects and the likelihood of inflation remaining subdued in advanced economies. They also pondered whether the current regulatory and policy frameworks were well suited to support financial stability and growth. In what follows we provide a brief summary of the issues debated by the panellists, who spoke under Chatham House rules.
Panel 1: Is strong growth back in the transatlantic economy? Will it last?
Growth was strong on both sides of the Atlantic in 2017. However, some weakness had recently appeared in soft and hard indicators, in particular on the European side of the Atlantic. Would these developments indicate that the transatlantic economy as a whole had already reached and passed its growth peak, or rather that it was stabilising on a high plateau despite regional asymmetries?
To appropriately answer the question, one had to consider developments in the global economy, as US growth in 2017 reflected, to some extent, favourable external conditions. In this respect, China was seen as a crucial driver of demand and the industrial cycle globally. Some indicators – in primisthe so-called Li Keqiang index (reflecting bank lending, electricity and freight) – pointed to some softness in the Chinese economy that would inevitably have some negative spillovers on China's trading partners. Moreover, uncertainties related to the possibility of protectionist trade policies were tilting the risks on the downside. This did not mean that the US economy was bound to face a cyclical slowdown in the near term, as there was considerable fiscal stimulus in the pipeline and financial conditions remained favourable. Still, headwinds were deemed to likely increase a few quarters in the future.
The European economy instead was facing less favourable conditions and a greater number of significant downside risks. Since January 2018 indicators had pointed to weaker economic conditions, including in Germany and France. At the time of the conference, nowcasting indicated a slowdown in 2018 for the euro area vis-a-vis more stable conditions for the US. The point was made that the euro area had entered a business cycle recovery later, but was now slowing earlier than the US, which was quite unusual because the US is typically the cyclical leader. Could this be the outcome of different policies? In both cases the recovery was mature enough that a slowdown down the road was to be expected. However, in the case of the US, growth deceleration appeared to be delayed by fiscal developments, the tax cuts and the expansionary budget deal for FY 2018, while in the euro area political risks (for example, the outcome of the Italian elections) and the possibility of an escalation of trade tensions seemed to have hit economic sentiment hard.
Panel 2: Will inflation continue to undershoot?
To answer the question, panellists thought it was important to consider several factors. For instance, in the US, foreign variables played a key role in affecting the dynamics of the Consumer Price Index. It was mentioned that a significant share of consumer goods sold in the US are imported from China. The diffusion of prices had also changed dramatically because of the Internet, but it was unclear whether e-commerce had led to a level effect rather than an inflation effect on prices.
Quite crucially, to assess whether inflation was likely to remain subdued one had to make a judgement on the relation between slack and inflation. According to several economists and policymakers, the textbook model of a relation between output gap and inflation – the Phillips curve – had been called into question by the recent inflation dynamics. Participants in the panels considered that although the Phillips curve may have significantly flattened due to the decline in the bargaining power of trade unions or to globalisation forces, the link between slack and inflation had not gone away (even if its predictive power had been significantly weakened).
When considering the Phillips curve, it was important to look not only at the unemployment rate but also at the employment level, as there had been considerable fluctuations in the labour participation rate (in particular in the US). The Phillips curve should ideally reflect all labour market data (vacancy, filling rate, etc.). There were also some important selection effects in the labour market. For example, in Germany unemployed workers were very different from the average hire, as unemployment is skewed toward low-productivity workers.
Looking at the specific situation of the UK, some non-linearities could be detected. For instance, some shifts in the UK Phillips curve seemed attributable to oil prices, productivity growth, and the financial crisis headwinds. Therefore – at least for the UK – there seemed to be a slow-moving trend in prices reflecting movements in the exchange rate and a cyclical component reflected in commodity prices. This left a moderate role for slack and inflation expectations.
Panel 3: Are the current rules suited to maintaining financial stability and delivering economic growth?
Participants agreed that since the beginning of the global financial crisis the euro area had made great progress with regard to the regulation and supervision of its financial sector. The banking union was created in two years under stressed conditions. The Single Supervisory Mechanismwas a key element in the structure of the banking union, although building a joint culture of supervision still required time-consuming efforts. The second major achievement was the creation of the Single Resolution Mechanism. However, progress toward a banking union was deemed to be incomplete – still missing were key components such as a European Deposit Insurance Scheme and agreement on the appropriate fiscal backstop (like any other banking jurisdiction). Moreover, there was a need to create a European framework for insolvency, as there were widespread inconsistencies among the insolvency frameworks at the national level.
The panel also emphasised the need to develop concrete steps to manage crises in large institutions on both sides of the Atlantic. Other issues for transatlantic cooperation on financial services included how to handle fintech, as it created opportunities to transform sectors of the economy but it could also be a threat for stability. Finally, panellists highlighted a need for savvy IT staff in regulation, due to the increased threat of money laundering and ransomwares, as well as extensive cyber-risk.
The general message that emerged in the conference panels and floor discussions was that, ten years after the crisis, transatlantic relationships are at a crossroad. The US and the EU both had a good year in 2017, and the near-term outlook remains favourable. However, downside risks are increasing and cloud the mid-term horizon. Against this backdrop, the euro area needs to make significant progress toward completing its architecture, so as to make the economy more resilient and able to withstand external shocks.
On its side, the US has to take advantage of the expected acceleration in economic activity to achieve maximum sustainable employment in a context of price stability. As neither the US nor the EU are insulated from global spillovers, an escalation in trade tensions would have significant economic consequences on both sides of the Atlantic. However, this is not a foregone conclusion and there is room to uphold and strengthen the transatlantic relationship. Such an outcome would help defuse some of the medium-term downside risks identified by the conference, ensuring the continuation of the current economic expansion.
Authors’ note: The views expressed in this column are those of the authors and do 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.