Friday, 19 July 2013

NZAE conference update - some slides from Maurice Obstfeld's speech

posted earlier a summary of Prof Obstfeld's impressive keynote speech at the NZAE conference on  "Finance at Center Stage: lessons from the Euro Crisis". At the time I mentioned I'd write some of his slides when they became available on the NZAE conference website, so here they are.

The first one that especially piqued my interest was this one about house prices in the Eurozone (with the US included for reference). Bubbles had developed pre-GFC in a wide range of housing markets, and are mostly deflating since, notably in Ireland (green), the US (dashed red), Greece (solid red), and Spain (light purple). On the downside, the unwind poses major problems for banks (who lent on the boom-time valuations of property) and households (negative equity and serviceability issues), but, on the upside, at least the process of setting saner prices and cleaning up the mess is underway.

It's more troubling, however, that some markets rose strongly but haven't dropped from their pre-GFC levels, notably France (bright blue), Finland (brown), and Italy (purple). It may be that the underlying supply/demand characteristics of the French housing markets genuinely explain the ongoing high prices: Paris for example is still a highly desirable city with limited supply. And there may be good reasons for the behaviour of the Finnish market (about which I know nothing). House prices holding up in Italy, however, look harder to explain.

Overall, you're left with the queasy feeling that there is still quite a bit of house price adjustment yet to happen in parts of the Eurozone, and on the policy front some urgency to have Eurozone-wide bank assistance programmes in place before it happens.

The second slide that caught my eye was this one, which shows real interest rates in the PIIGS (Prof Obstfeld prefers to call them by the less offensive GIIPS) compared to Germany. And the lesson here is that one monetary policy did not fit all. In Ireland, in particular, the economy pre-GFC was very strong, prices and wages were rising, and real interest rates were piffling or negative. No wonder the house market ignited.

This is all, of course, with 20:20 hindsight, but even at the time it would have been a good idea to have had some levers to pull to offset an ECB setting of monetary policy that was wildly too loose for parts of the Eurozone (or possibly this is a roundabout way of saying the Eurozone economies never met the criteria for a monetary union in the first place). Either way, the lesson here is something to remember if the idea of a common currency with Australia ever resurfaces.

And the third and final one I'd like to show you is this, which charts the competitiveness of the peripheral GIIPS back to the start of the Euro: a rising graph means worsening competitiveness. If you want to look at the data for yourself, these are the Harmonised Competitiveness Indices that the ECB prepares, they come in three flavours (based on consumer prices, GDP deflators, or unit labour costs), and you can access them here

Very notably, competitiveness in Ireland (green) and Spain (red) deteriorated badly in the early 2000s - but only Ireland has been able to do anything effective about it, and without getting into the whole austerity debate, you can see why it has been the poster-child for getting its act together. You can also see where Greece's reputation for failing to deliver on reforms has come from, and what effect its inactivity has been having on its eventual ability to trade its way out of its problems. And while Italy's and Portugal's competitiveness never blew out the way it did in Greece, Ireland and Spain, they haven't been doing much to improve theirs, either. 

Finally you can see how well Germany has been doing, at least in part because it was fortunate to do some labour market reform before the GFC struck. As a result its latest (May) unemployment rate is 5.3%, under half the rate of largely unreconstructed France (10.9%). Prof Obstfeld's graph didn't include France, so I've dug out the data: on the same basis (Q1 1999 = 100 to Q1 2013), French competitiveness on a unit labour cost basis deteriorated by 1.7%, whereas Germany's improved by 18.5%.

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