Opinion

Opportunities and risks in Europe in 2018

The new year could very well see the positive story of 2017 continue in Europe – but a number of looming policy and political problems cannot be ignored.

By: Date: December 30, 2017 Topic: European Macroeconomics & Governance

This opinion piece was also published in Nikkei Veritas, Nikkei Asian Review, and Kathimerini

As 2017 draws to a close, it is a good moment to review the main risks for the upcoming year and explore some of the opportunities. Let’s start with the opportunities: 2017 has been a good year for the global and the European economy. GDP growth numbers have been revised upwards in Europe with the notable exception of the United Kingdom. Unemployment has been falling rapidly while employment is at an exceptionally high level.

2018 could very well bring a continuation of that positive story. Balance sheets of banks and corporations are stronger than a year ago. Banks have made progress with addressing their non-performing loan portfolios, even though a lot of work remains to be done. Corporate debt to GDP ratios have been falling. Meanwhile, fiscal deficits have also fallen so that the need for austerity is receding. France has enacted some important labour market reforms that should help with the labour market, meanwhile Italy should benefit from the labour market reforms enacted in 2015.

Yet, there are important risks. The most important policy area that will deserve careful deliberation and cautious action is monetary policy. As the global financial crisis unfolded, the European Central Bank (ECB) and other central banks greatly extended their monetary policy toolboxes and adjusted their operational frameworks.

The main characteristic of monetary policy in recent years is that the main instrument, the interest rate, has been at the zero lower bound and has de facto become ineffective. This has lead the ECB to follow in the footsteps of the US Fed and use other ways to implement monetary policy. These so-called unconventional monetary policies have left central banks with large balance sheets. In fact, the various measures of the ECB have resulted in the quadrupling of the size the ECB’s balance sheet to above 4 trillion euros, more than 2 trillion euros resulted from the government bond purchase programme.

As growth picks up in the euro area, the discussions on when and how to normalise monetary policy will accelerate. One important question is whether to first normalise the interest rates, i.e. increase the main interest rate, and then to phase out government bond purchases or the other way around. Overall, the European policy makers seem to prefer to first phase out bond purchases and only then move the short term interest rate. As a result, the yield curve could first steepen before it may gradually shift upwards. This sequencing of the normalisation process would correspond to that of the US Federal Reserve, which started with tapering (ie gradually reducing asset purchases), then increasing key policy rates slowly before reducing passively the size of the balance sheet.

The debate on the optimal size of the central bank’s balance sheet has not yet been settled. It is a question of fundamental importance on whether and how quickly to reduce the balance sheet size of the ECB and absorb the large amounts of liquidity in the markets. If liquidity is removed too quickly, long-term interest rates and asset prices may react drastically. This could result in substantial financial instability. In my view, the ECB should therefore only gradually reduce its balance sheet size. But even then, financial stability risks may be the most important thing to watch next year.

There are other risks: a number of elections, most notably in Italy may change the political landscape in Europe substantially. Progress has been made on avoiding a cliff-edge Brexit but politics remains highly unstable and could still undermine a smooth progress towards a close trade agreement. Meanwhile, Germany still has no government and any broader debate on how to shape the future of Europe’s monetary union is therefore on hold. So overall we look into another exciting year ahead.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint.

Due to copyright agreements we ask that you kindly email request to republish opinions that have appeared in print to [email protected].

Read article More on this topic
 

Opinion

The Independence of the Central Bank at Risk

The ruling of the German Federal Constitutional Court (GFCC) of May 5 on the ECB’s monetary policy affects not only the relation of Germany to the European Central Bank (ECB) and the Court of Justice of the European Union (ECJ) but also the constitutional foundations of monetary policy.

By: Peter Bofinger, Martin Hellwig, Michael Hüther, Monika Schnitzer, Moritz Schularick and Guntram B. Wolff Topic: European Macroeconomics & Governance Date: June 2, 2020
Read article Download PDF
 

Policy Contribution

COVID-19’s reality shock for external-funding dependent emerging economies

COVID-19 is by far the biggest challenge policymakers in emerging economies have had to deal with in recent history. Beyond the potentially large negative impact on these countries’ fiscal accounts, and the related solvency issues, worsening conditions for these countries’ external funding are a major challenge.

By: Alicia García-Herrero and Elina Ribakova Topic: Finance & Financial Regulation, Global Economics & Governance Date: May 28, 2020
Read article Download PDF More by this author
 

Policy Contribution

European Parliament

The European Central Bank in the COVID-19 crisis: whatever it takes, within its mandate

To keep the euro-area economy afloat, the European Central Bank has put in place a large number of measures since the beginning of the COVID-19 crisis. This response has triggered fears of a future increase in inflation. However, the ECB's new measures and the resulting increase in the size of its balance sheet, even if it were to be permanent, should not restrict its ability to achieve its price-stability mandate, within its legal obligations.

By: Grégory Claeys Topic: European Macroeconomics & Governance, European Parliament, Testimonies Date: May 20, 2020
Read article More on this topic More by this author
 

Opinion

How will COVID-19 impact Brexit? The collision of two giant policy imperatives

The United Kingdom left the European Union on Jan. 31, 2020. Now, the U.K. must decide whether and how to extend the transition period, currently set to expire at the end of 2020.

By: Rebecca Christie Topic: European Macroeconomics & Governance Date: May 19, 2020
Read article Download PDF
 

Policy Brief

Rebooting Europe: a framework for a post COVID-19 economic recovery

COVID-19 has triggered a severe recession and policymakers in European Union countries are providing generous, largely indiscriminate, support to companies. As the recession gets deeper, a more comprehensive strategy is needed. This should be based on four principles: viability of supported entities, fairness, achieving societal goals, and giving society a share in future profits. The effort should be structured around equity and recovery funds with borrowing at EU level.

By: Julia Anderson, Simone Tagliapietra and Guntram B. Wolff Topic: Energy & Climate, European Macroeconomics & Governance Date: May 13, 2020
Read article Download PDF More on this topic
 

Policy Contribution

The European Union’s post-Brexit reckoning with financial markets

In the negotiations between the European Union and the United Kingdom over their future relationship, we see a high probability of a weak contractual outcome, given the dominance of politics over considerations of market efficiency.

By: Rebecca Christie and Thomas Wieser Topic: European Macroeconomics & Governance Date: May 13, 2020
Read article More on this topic More by this author
 

Opinion

The message in the ruling

The German Constitutional Court's ruling on the ECB's asset purchase programme is open to much criticism but it can hardly be blamed for raising an important question.

By: Jean Pisani-Ferry Topic: European Macroeconomics & Governance Date: May 12, 2020
Read article More on this topic More by this author
 

Podcast

Podcast

An analysis of the German Constitutional Court's ruling on the ECB QE programme

The German Constitutional called today on the ECB to justify its bond-buying program. What does today's ruling of the German Constitutional Court mean for the ECB's QE program? Could such a decision open a precedent when it comes to contesting EU law? Today, Giuseppe Porcaro and Guntram Wolff are joined by Franz Mayer, chair of Public Law at the University of Belefield, to analyse the German Constitutional Court's ruling.

By: The Sound of Economics Topic: European Macroeconomics & Governance Date: May 5, 2020
Read about event More on this topic
 

Past Event

Past Event

The Sound of Economics Live: An analysis of the German Constitutional Court ruling on the ECB QE programme

What does today's ruling of the German Constitutional Court mean for the ECB's Quantitative Easing programmme

Speakers: Franz Mayer, Giuseppe Porcaro and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: May 5, 2020
Read article More on this topic
 

Opinion

Monetisation: do not panic

The extraordinary operations that are under way in most countries in response to the COVID-19 shock have raised fears that large-scale monetisation will result in a major inflation episode. This column argues that so far, there is no evidence that central banks have given up, or are preparing to give up, on their price stability mandate. While there are obviously some reasons to worry, central banks are doing the right thing and the authors see no reason to panic.

By: Olivier Blanchard and Jean Pisani-Ferry Topic: Finance & Financial Regulation Date: April 14, 2020
Read about event More on this topic
 

Past Event

Past Event

The Sound of Economics Live: The macroeconomic policy response to the COVID-19 crisis

Which macroeconomic policy response is the best option to deal with the crisis currently unfolding and will ensure that the recovery will be as quick as possible?

Speakers: Grégory Claeys, Giuseppe Porcaro, Lucrezia Reichlin and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: March 31, 2020
Read about event
 

Past Event

Past Event

CANCELLED: How adequate is the European toolbox to deal with financial stability risks in a low rate environment?

Bruegel is delighted to welcome the governor of the Central Bank of Ireland, Gabriel Makhlouf. He will deliver a keynote address about how adequate the European toolbox is to tackle financial stability risks in a low rate environment. Following his speech, a panel of experts will further discuss the topic.

Speakers: Gabriel Makhlouf, Guntram B. Wolff and Agnès Bénassy-Quéré Topic: European Macroeconomics & Governance, Finance & Financial Regulation Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: March 31, 2020
Load more posts