Commission warns about centrifugal forces in euro area

 

FT Deutschland has obtained a paper from the European Commission, which warns about the long-term effects of diverging competitiveness in the euro area. The paper says Germany has improved its competitiveness to pre-unification levels, while Italy and Spain among others have suffered a massive loss in competitiveness. The paper recommends that those countries should improve their competitiveness through cost reductions. But it also cites a lack of policy co-ordination as a reason for the economic divergence. While governments co-ordinate fiscal policy to some extent, there is no functioning mechanism in place for other areas of economic policy. The FTD article says EU Commissioner Joaquin Almunia also wants to include a discussion on wider economic policy into the regular agenda of EU finance ministers. The analysis is contained in a 17-page paper, which was distributed to finance ministers ahead of the Ecofin meeting.

 

Russia/Ukraine cut off gas supplies

The Russian/Ukrainian gas dispute has led to severe supply shortages in Europe. The FT reported a warning by Eon of Germany that supplies were about to collapse during the coldest weather period this winter. European countries were reacting by increasing supplies from other sources, and there is now a lot of diplomatic activity going on to seek a resolution to this long-lingering dispute. Slovakia announced it would declare a state of emergency.

 

Huge exchange rate turbulence

The e euro/dollar rate lost 4.1% in just two days, the biggest swing since 1999, as financial markets are preparing for another strong interest rate cut by the ECB. Yesterday, the euro traded at $1.33, having been as high as $1.40 previously. The pound also restored some strength and rose to Pounds 0.9050. One reason for the change in market expectations is the increased likelihood of euro area rate cuts this month. Last month, the ECB signalled that it would slow down the speed of rate cuts but these signals have since reversed. One reason for this reversal is the faster than expected fall in inflation, which in December came down to 1.6% for the euro area. El Pais notes that for the first time Spanish inflation is lower than that of the euro area as a whole. This is a dramatic decline after inflation hit 5.3% in July, and is a sign how severe the recession has hit the country. But the trend towards extreme declines in inflation may be ending, as the oil price is now back up to $50pb.

 

Germany considers €100bn fund to rescue industrial conglomerates

FT Deutschland writes that Angela Merkel is apparently concerned that the financial crisis will hit large German industrial groups, which may not find easy access to credit. The government is therefore planning to set up a €100bn fund, to be decided as early as Monday, alongside with the next stimulus package. The main problem at this stage is not the size of the fund but how it should be administered. The article says the option currently favoured is for the state-owned KfW bank to run the fund.

 

Rescue strategies under scrutiny

A Le Monde editorial argues that the rescue packages in Europe were sufficient to prevent a bankruptcy on the scale of Lehman Brother but they did not succeed to relaunch economic growth. Whether a rescue package succeeds is not a question of conditions on recapitalisation, as commonly perceived. There is no way to conclude that the UK and Germany, which both chose to attach strict conditions during a pre-election period, is performing any different than France. Though from a political point of view it is only natural to impose conditions.

 

Wolf on the crisis

In his FT column, Martin Wolf says the crisis is proof that the US can no longer continue to act as the global consumer of last resort, running persistent deficits. This means that the US alone will not be able to fix the situation. It will need helpers in the surplus countries. Global policy co-ordination is becoming an absolute necessity for this crisis to end. Without it, the fiscal stimulus programmes will not produce more than just short-term relief, and when unemployment continues to stay high beyond the stimulus period, there is an acute danger of a protectionist spiral, with beggar-thy-neighbour currency devaluations.

 

 

Munchau on the policy response

Wolfgang Munchau says in his FT Deutschland column that we still have no agreement among experts on the causes of the Great Depression, citing Charles Kindleberger’s analysis of the debate. The same applies even more to the current crisis. Roosevelt’s response in the 1930s was fundamentally non-ideological. He tried out various policies and stuck with those that worked. That was probably the best approach to handle a policy response in a crisis which is not fully understood. Translated to our situation today, it is probably best to deal with this crisis both on a cyclical as well as structural level, to address the short-term fall in GDP through stimulus packages, and to fix the underlying imbalances that have contributed to this crisis as well as reform of financial regulation.

 

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