Interview with Laurence Boone, OECD Chief Economist
"Germany can and should do more in terms of fiscal policy"
Mrs. Boone, the world economy has slowed down considerably and the uncertainty and risks, such as trade conflicts and the Brexit chaos, are immense. How great is your concern about a global recession?
Global growth in the second half of 2018 was much weaker than almost all experts had expected. A large part of the current forecast corrections for 2019 are precisely due to this, i.e. to a mechanical effect due to the lower starting basis. However, the big question now is how the factors that caused the slowdown in 2018 - the trade disputes, the slowdown in China and the political risks - will evolve.
And what is your answer?
On trade, there are discussions between the US and China, between the US and the EU, between the US and Turkey. We must certainly prepare ourselves for long lasting discussions over trade issues. This will weigh on the economic outlook.
That doesn't sound very confident - although there is growing hope for an agreement between the US and China.
We are dealing with very complex issues between the US and China, such as the protection of intellectual property or forced technology transfer. These issues cannot be resolved in one- or two-month negotiations. It is therefore very likely that even if there is an agreement now, it will only cover part of the issues and the discussions will continue. Even with an agreement between Washington and Beijing, then there are ongoing discussions with the EU, not all uncertainty will vanish into thin air - and that will weigh on companies' investment and employment plans. We will certainly be dealing with this issue for a few more months and perhaps even for a few more years.
What about China's economy? How big are your worries?
There are certainly cyclical reasons for the slowdown of the Chinese economy. But part of it is due to structural factors. These include demographic developments, and as China has already gone through an immense catch-up process, the growth rates of the past cannot be achieved forever. China is now making extensive use of monetary and fiscal policy to prevent the economy from slowing down too much. But there is some uncertainty on how these measures, such as tax cuts, will work.
So that doesn't bode well for the global economy either?
China has recently contributed a third to global growth - that's very significant. If the Chinese economy now grows more slowly, it has a global impact. In addition, there is a realignment of the Chinese economy, meaning shifting demand from investment to consumption. That is the right way to go: it strengthens the Chinese economy and makes it more resilient to shocks. However, the advanced economies in particular will have to adjust to lower demand for some of their exports.
Your third concern was political risks. What are you thinking about - Brexit?
In Europe there are some political risks. There is, of course, Brexit, but also the recession in Turkey or the difficulty of completing the monetary union. Little progress has been made on the banking union, and the discussions on a common euro fiscal capacity and a common deposit guarantee scheme are stagnating. Progress on these would raise confidence.
With regard to Brexit, the outcome is still open.
Brexit causes a lot of uncertainty. This is being felt above all in the UK. Investment growth has come to a standstill in the past two years. Compared with comparable economies such as the US or France, the UK has lost around 2% in GDP. Even if an agreement were to be reached now on a soft Brexit, only then will the transition phase begin with the negotiations on future relations. This will be much more difficult. So Brexit will continue to create some uncertainty.
How worried are you about a hard cut between the EU and Britain?
The best thing for everyone would be for Britain to maintain as close relationship to the EU as possible.
Your list does not include the US economy, although observers are increasingly worried about a possible recession after the extremely long upswing - possibly as early as 2020.
The US economy is experiencing one of its longest upswings in history. This upswing was extended by fiscal policy. Now this effect is slowly coming to an end. The US economy is losing momentum and this will continue in 2020. But that is normal. The fact that the Fed is now pausing its interest rate hikes provides a little buffer. The financing conditions, which had tightened significantly at the end of 2018, have eased again. We expect the US economy to continue its soft landing.
And this also applies to the global economy - to come back to the initial question?
We continue to expect the global economy to weaken, and then recover somewhat. But there are risks. The combination of risks has the potential to derail the global economy. That makes it all the more important that political decision-makers act now. For monetary policy, there is little room for manoeuvre. Policy-makers should look at other available tools, fiscal and structural policies.
What do you mean in concrete terms?
In order to ensure stronger growth, other policies are needed now, especially in Europe. Structural reforms are urgently needed in all EU countries to increase productivity and growth potential. For example, we need to allow more competition and reduce regulation and bureaucracy. There are lots of things that could be done and that would help quickly. Fiscal policy must also play a greater role. In Europe some countries have low debt ratios and a lack of public investment, such as Germany, the Netherlands or Finland. With a small coordinated fiscal support in countries that can afford it and the necessary structural reforms for all countries, growth in Europe could increase by 0.5 percentage points as early as 2020. That is a lot and should be tackled now.
However, the German government is sticking to its balanced budget despite a significant economic slowdown. Is Germany too obsessed with the "schwarze Null"?
Germany is absolutely right to advocate healthy public finances everywhere. But if you have healthy public finances and there is a need for public investment, you should also use this leeway and invest the available money sensibly - for example in the digital infrastructure. Germany can and should do more in terms of fiscal policy and that will sustain its own competitiveness. How, for example, can one be competitive in autonomous driving without the necessary high-performance data lines and possibilities for collecting data? The positive side effect: a fiscal stimulus in one country in the euro zone will also increase the demand for goods and services in other countries, and that without exchange rate frictions. This is fantastic and unique in the world.
But what would be even better, if I understood you correctly, is a common fiscal policy in the euro area?
We know how difficult agreements between individual governments are. At the same time, we can see how quickly the ECB, for example, takes decisions. It would be the same with a common fiscal capacity. It is not a question of replacing national budgets. It is an additional instrument. A common euro area fiscal capacity would make it possible to take decisions more quickly, to respond better to problems and, ultimately, to ensure faster recoveries and higher growth rates. At the same time, this would open the door to creating a safe asset in the euro area. That is what the monetary union absolutely needs. This, in turn, would also increase the chances that the euro will gain more weight internationally.
And that would be an advantage?
Absolutely. It would be good to rebalance the importance of international currencies, with a stronger role for the euro.
You mentioned the US Federal Reserve's pause in interest rate normalization. Other central banks around the world, such as the European Central Bank (ECB), have also recently embarked on a much more cautious course. Do you think that's right at the moment?
Yes, it is absolutely appropriate that the Fed has now taken a pause from raising interest rates. Inflation in the USA is within the 2 percent target range, but not higher either. The unemployment rate is at a record low, but there is still a lot of untapped potential for higher participation in the labor market. So there are no excesses or exaggerations. At the same time, the Fed has already noticeably normalized its key interest rate and balance sheet. Now the economy is cooling down. So it makes sense for the Fed to wait and see how things develop. Some are even calling for or speculating on imminent rate cuts by the Fed - not least US President Donald Trump's new candidate for the Fed, economist Stephen Moore.
As I said, in the USA growth is on its course to stabilizing at the potential rate and inflation is within the target range. There is currently no reason for the Fed to loosen its monetary policy. The wait-and-see attitude is now absolutely appropriate.
And what about the ECB? At the beginning of March, it postponed the interest rate turnaround at least until 2020 and even announced new money injections for the banks. Do you think this is also appropriate?
Absolutely! In the euro zone, headline and core inflation are still some way from the ECB's target. So what the ECB did at the beginning of March was absolutely right. The ECB currently prefers to be too cautious rather than too aggressive - and that is understandable and appropriate. But it is also clear that the ECB cannot do everything on its own. In recent years it has done everything it could within its mandate, and it has acted very creatively. The ECB has made a decisive contribution to the cohesion of the euro area. But the ECB cannot take all the responsibility. In the euro area it is also super important that the burden is taken off monetary policy and that fiscal and structural policies take on more responsibility.
But isn't there also the risk that monetary policy will be too cautious and act too late - and that this will pose dangers to financial stability?
If there are risks to financial stability, regulators and supervisors should act, using prudential, regulatory and supervisory tools. Then it is not primarily monetary policy that is called for. The ECB should not be blamed for something for which it is not responsible. If the central banks were now to normalize monetary policy unduly, they would run the risk of stalling growth completely. What they need is to communicate clearly their intentions to avoid surprising markets.
Are central banks too focused on the financial markets? Whenever there is unrest and volatility, they seem to want to intervene - first and foremost the Fed. Doesn't that also entail dangers such as false incentives?
I don't share that assessment. The Fed did not react to the volatility on the financial markets, but to new data on growth and inflation. Greater volatility in the markets is unavoidable if monetary policy is normalized after a very long period of unconventional measures. Central banks need to look through and keep their sights on the target. But monetary policy must be aligned with data developments. This is what the Fed has done: It has adapted its communication to the weaker outlook.
But has the economic picture really changed in the past three or four months to such an extent that this can justify the Fed's turnaround?
The economic data over the past three to four months have largely been worse than we and almost all experts expected, for reasons that do not seem temporary. Then it is not surprising if a central bank reacts and adjusts its course.
The financial markets reacted very positively to the turnaround by the Fed and other central banks. At the same time, however, many risks remain. Do the financial markets trust too much that everything will be all right?
The financial markets sometimes take a long time to price in risks correctly. This has been demonstrated over the past two years by their muted reaction to the trade disputes. Even a hard Brexit does not seem to have been priced in at the moment, because it is difficult to do so. That certainly harbors dangers and the risk of greater volatility if repricing happens suddenly. The problem is that most financial markets react non-linearly. They do not adjust their assessments continuously, but often abruptly. This can cause a lot of volatility and distortions and can have very disruptive consequences for the real economy as well.
Do you see the risk of a new global financial crisis in the next three to five years?
First of all, banks are much better capitalized today than they were a few years ago. A crisis like 2008 seems rather unlikely at the moment. The problem, however, is that financial crises do not repeat themselves. That would be too easy. The next crisis will be different. We all have to be very vigilant. This applies, for example, to the non-banking sector, especially asset managers. For example, what happens to the liquidity of ETFs if there is a fire sale of assets? We need a lot more information and more control.
Europe's banks are lagging far behind their US competitors, and not least the major German banks Deutsche Bank and Commerzbank are seen by many as problem children. How worried are they about Europe's banks?
Europe has started to recognize banks’ issues in the crisis later and more slowly. The situation was quite different in the USA - alongside the more aggressive fiscal and monetary policy. That said, progress has been made in Europe on non performing loans. What worries me is that the EU banking union that was decided in 2012 has not yet been fully implemented. For example, the Edis deposit guarantee scheme is missing. That is regrettable. The banking sector and banking supervision are still too national. Cross-border activities are still too limited within the euro area.
This would hardly change if Deutsche Bank and Commerzbank were to merge in Germany or Bankia and Sabadell in Spain.
I do not comment on specific banks. If Europe wants to compete globally with the US and China, it needs strong European players.
Let us conclude by returning to monetary policy, with a view to the future: There is currently a debate raging, especially in the USA, about a new framework for central banks. One of the issues under discussion is "average inflation targeting", in which past mistakes must be compensated for in the future - in both directions. Does monetary policy need a new framework?
Basically, it is always right to think about one's own actions and to question them. However, central banks should only change their framework if they are one hundred percent sure that another will really deliver better results than the current one. Central banks must be extremely cautious. Otherwise, there is an issue of communication. At the moment I see no convincing evidence that any other framework would really be better than the one we have. In my view, it would be premature to initiate a regime change at this time.
In the Fed, the discussion is obviously also raging with the idea of wanting to tolerate inflation above the 2 per cent target - after years below the target value. What do you think?
The Fed has always said that its inflation target is symmetrical. So after a phase of undershooting the target, a phase of overshooting is not a big surprise and is appropriate. What is crucial is that the Fed clearly communicates its intentions. Inflation expectations must remain anchored at the inflation target.
Criticism of the central banks has increased worldwide. Do you see the danger that the era of independent central banks could come to an end?
I wouldn't go that far. But it is absolutely crucial to preserve the independence of central banks. That means not expecting too much from them and not overburdening them with tasks they are not mandated for. Because at some point it will become highly political and a threat to independence. The central banks should focus on price stability [and on growth where it is their mandate], not on financial stability, not on securing the sustainability of public debt. We should simply let the central banks do their job - and that is the best guarantee that people's purchasing power will remain secure.