En route to hit the zero bound

 

 

ECB rates down 0.75pp, BoE down 1pp, Bank of Sweden down 1.75pp, and the markets immediately priced in further rate cuts in the New Year, for example 0.5pp for the euro area. The ECB forecast a euro area contraction next year of 0.5-1%, with risks on the downside. The FT reports that the decision was not unanimous as some council members worried about laying the seeds for the next crisis, and about running out of ammunition. Trichet himself gave no hints about further rate cuts.

 

Elsewhere in the world, oil fell to under $45 with Merrill Lynch now predicting a trough of $25.

 

The rate cuts failed to lift the mood among investors. The European indices were little changed, and New York, the previous days’ gain were reversed again. The yield on 10-year German bunds fell briefly to below 3% yesterday, a multi-decade low, according to the FT, and the 10-year US Treasury  hit a 53-year low of 2.54%.

 The following chart is from the Calculated Risk blog.

There was no relaxation on credit markets. The iTraxx Crossover index remained near the 1000bp mark (meanings it costs €1m a year to insure a €10m portfolio of bonds in the iTraxx Crossover index). The iTraxx Europe index of investment grade bonds broke through 200bp for the first time.  

 

Sarkozy unveils €26bn stimulus package

Les Echos has the details on the French stimulus of €26bn, to be spent over two years, which amounts to a total of 1.3% of GDP, will be drive the budget deficit up to at least 4% in 2009. The paper said Sarkozy acted under shock and awe leitmotif. The package includes help to the car industry, four new TGV lines, a new canal to the north of Paris, cut in employer social contribution for small companies. Sarkozy also distinguished between good and bad deficit, saying that our children will reap the fruits of these investments. An analyst quoted by the FT said this plan is better at raising future GDP than current GDP.

 

The FT reports that Mr Sarkozy will attend a summit with Gordon Brown and Jose Manual Barroso – and without Angela Merkel – in London to press the case for the European-wide stimulus programme.

 

In a comment, Frankfurter Allgemeine notes that the French stimulus package does not fulfil the criteria of timely, temporary and targeted. The investments in construction take at least until 2010 to show any effect, and will prove very difficult to revert, so that much of the 1.3% programme is likely to turned into a structural increase in the French deficit.

 

Brittan on Friedman

In his FT column, Samuel Brittan dug up a 1948 paper by Milton Friedman, in which he proposed four steps to achieve economic stability. First, a long-term policy on expenditures, second a predetermined programme on transfer payments, third, a progressive tax system based on income tax to balance the budget, and fourth, deficit to be financed entirely by printing money. Brittan is incensed by the British government’s announced expenditure path, the preannouncement of future taxes to pay for the current tax cuts, saying that this is a textbook example of how fiscal conservatives would construct an object lesson against the use of fiscal policy.

 

Should central banks deal directly with households?

One way of solving the banking crisis was suggested by Eric Lonergan, who suggested in Martin Wolf’s forum that central banks buy their own helicopters and deal directly with households, bypassing the banking system. At the moment we are using expensive and ineffective fixes of the financial system. All that is lacking is  a legal and institutional framework. Central banks are well placed for such an operation, as it effects the widening of the monetary base.

 

How to prevent protectionism?

VoxEU.org has just published another ebook in their  “What leaders should do in the Crisis” series, edited by Richard Baldwin and Simon J Evenett. This one focuses on trade. Unless world leaders strengthen trade cooperation, new tariffs and competitive devaluations could trigger a protectionist spiral of WTO-consistent trade barriers. To rule this out, world leaders should: 1) Reduce protectionist pressures by fighting the recession with macroeconomic polices; 2) Translate APEC and G20 leaders’ words into deeds by agreeing a framework for concluding the Doha Round; and 3) Establish a real-time WTO/IMF surveillance mechanism to track new protection.

 

Is Germany weakening Europe?

Charles Grant has an interesting comment in the FT, in which he argues that Germany has become more unilateralist, a stance that is threating the European interest. He mentions five areas: Germany’s handing of the financial crisis, Germany foot-dragging on the EU Commission climate change proposals, Germany’s special relations with Russia, the refusal to impose sanctions on Iran, and Germany’s lack of enthusiasm to strengthen EU defence.

 

 

 

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