Notes for Bloomberg (Turkey) Interview. December 3rd 2018

Slow down in EA and its effects – is the slow-down a serious event?
Too early to say. Clearly some slow down is there, but the question is whether this is just a respite from an unsustainable fast pace or whether it is something worse. In addition, it is too early to say whether this will be accompanied by a recurrent heterogeneity of developments among countries. This heterogeneity, if it will indeed come, may not follow the usual core/periphery fracture line, but be more concentrated in Italy, aggravating the prospects in that country.

In any case the slowdown in the €-area is not very high in my list of worries. Probably the first, at least on a medium term basis, is the effects of protectionism on the global economy. Second comes the situation in Italy, which could more directly affect the euro area. Third is Brexit. Possibly fourth is the fear that financial instability may be brewing again in the global economy. For lack of precise information, I do not mention the Chinese financial market in this list and we may touch later about the US.

Employment conditions started to go sideways in the EA
To a large extent this is the other side of the medal of the possible slow-down in activity. However there is also a more structural component to it. If I was the fiscal authority in the euro-area, and especially in some countries in the periphery, including Italy, I would concentrate all available fiscal resources in reducing the cost of youth labour. I regard the dualism of the job market, where young people are strongly disfavoured, as very damaging economically, socially and politically.

Inflation losing momentum.
Also inflation is connected to activity prospects and, of course, the ECB has been disappointed many times in its hope that inflation would eventually reach back to its 2% target. Specifically, inflation has been lower and employment higher than its expectations, pointing out to the fact that labour supply has evidently been higher than expected. The question is whether this is going to continue or whether it was a persistent phenomenon that is now starting to close. I think that the signals coming from the labour market, in particular about wage developments, are quite reassuring in this respect. I give, in this light, particular importance to wage developments in Germany, which acts as a sort of cap to wage developments all through the euro area.

Will ECB opt out of its expansionary program?
Unless something very bad happens to the euro-area economy in the next few weeks, and I don’t know why this should happen, I think the ECB will close down its program as announced. Specifically I don’t think that it would want to prolong the program to deal with what is happening in Italy: neither politically nor politically would this be possible. The consequences of the exit from QE should, on aggregate level, be manageable since the market has had all the time to adjust and the maintenance of the huge holdings of securities, by means of reinvestment, will keep the stock effect on prices intact.

When will the first hike come?
Again, unless something unexpected happens, I think the third quarter of 2019 is the most likely period. But I would not exaggerate the importance of this event: more important than the timing of an actual first increase, probably smaller than the usual 25 bp, will be the prospects for interest rates going forward and I think these will very much depend on what happens to inflation. The best way to think about this is that interest rate moves as homeostatic mechanisms, with the ECB reacting to incoming news to keep inflation as close as possible to its objective.

How about Fed?
One could think that they are in the sweetest spot, with both inflation and unemployment at the desired level. But I have two preoccupations:
1. The first one is about the relationships between President Trump and the Fed. I know some observers discount the importance of the quite extraordinary presidential tweets about the Fed, contrasting them with the overall good choices by the President about Members of the Fed Board. However, I am not reassured, after all saying that the tweets are irrelevant is tantamount to saying that the President is irrelevant, which I find hard to accept. I don’t think that the most recent statement by the Fed Chair (“rates are just below the range of the neutral level”) is a caving in of the Fed, but the very fact that some market participants could interpret it as such gives me thought.
2. I see the task of the Fed as complicated by two, interacting, factors. First, again, protectionism by the US administration, second, the strongly cyclical American fiscal policy, where fiscal stimulus is imparted to an economy that is probably beyond full employment. Again, I know many observers, and even the Fed, do not seem to be too worried by this, but I wonder whether there is some complacency here because currently developments seem to be so positive in the US.