Hawks and Doves Series #3

15310447_412011419189332_2002445799_nBy Riccardo Russo.

What’s ahead for 2017? During our first meeting of the year, we asked prof. Masciandaro about financial implications stemming from recent events in the Italian banking system, what we may expect from Draghi’s speech tomorrow and much more on the “Trump effect”.

Let’s start from our neighbors: although the FED has started rising interest rate as you had forecasted, Mr. Trump’s agenda promises an aggressive fiscal policy needing to be financed. Will the new establishment push for a slowdown and a laxer monetary action?

Yes, and consequently a possible conflict between Mr. Trump and Ms. Yellen is likely to arise. On the one side, after the first hike in interest rate there are now expectations for a smooth increase in the upcoming months. On the other side, during the presidential campaign Mr. Trump promised both lower taxes and increasing investment in infrastructure. The more this fiscal expansion will be strong – especially if we consider that the US are in a positive cycle in terms of growth and inflation – the more there will be political pressure for a laxer monetary policy. If Ms. Yellen decided to avoid any accommodation, the climb of the interest rate could be faster and more robust than expected, triggering negative spillovers in terms of public deficit and debt.

Back home, what may we expect from the ECB Board meeting tomorrow?

A halt. Rather than hawks and doves, I would say it’s now time for the “pigeon” attitude, i.e. to prefer the status quo. In general, the pigeon attitude can be due to three main drivers: the first one is about uncertainty on the figures of our reference variables; the second is about governance and the lack of large consensus in the monetary policy committee; the third is a more behavioral one: given a choice, the distribution of gains and losses is not symmetric, it’s costlier to take one decision with respect to the other, that’s to say there is loss aversion. In Europe, a relevant monetary action has been already undertaken last December with a majority vote. Since then there has been no so relevant news to trigger a change in the equilibrium the ECB reached just one month ago. It’s better to halt.

Recent data signaled a 1.7 inflation rate in Germany. With the extension of the QE up to December, don’t we risk to kill the goose that lays the golden egg?

No. 1.7 is just a country figure, and the ECB is obliged to look at the European data. I guess that the possible German displease – if any – will be not enough for a change in the majority of the Board soon, therefore for a change in the policy implemented.

Do you deem the Italian banking system to be a threat to the European one?

In general, looking at the European banking data, there can be three possible sources of uncertainty in the asset values triggering instability: non-performing loans, real estate collaterals and illiquid assets, such as derivatives. Non-performing loans are the main problem of Italian banks, but we also have Spanish banks that can be severely threatened by the volatility of real estate prices and, on top of that, the balance sheets of German and French banks are characterized by a huge amount of illiquid assets. Nowadays, the ECB Supervision chaired by Danièle Nouy seems to be focused on non-performing loans only: it’s biased, and the bias is possible because since too much room is left to supervisory discretion. Without the supervisory bias, the Italian banking system per se does not represent a more severe threat than the German, the French or the Spanish one. But why the ECB watchdogs only care about non-performing loans? Given that the traditional economics cannot offer an explanation, a political economy approach can be more useful: the ECB supervision could be captured, aiming to please the more powerful European countries, i.e. Germany and France.


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