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The Global Economy
Monthly letter from Swedbank’s Economic Research Department
by Cecilia Hermansson
No. 1 • 31 January 2012
The fiscal pact is one step forward –strengthening
growth and support mechanisms will be harder
 The EU has agreed on a fiscal pact with binding balanced budget rules for the
euro countries (structural deficits may not exceed 0.5% of GDP). The pact is
necessary and improves budget discipline in the euro zone, but could be difficult to
assess. For example, it could be hard to sanction countries that breach the limits.
 The impact on demand in the euro zone of austerity could be quite negative. Now
that the pact has been agreed upon, it is important that attention turns to growth
and competitiveness – and that extensive structural reforms are implemented.
 The agreement bolsters the ECB’s confidence in the political commitment, paving
the way for more liquidity support for banks. This will improve stability in the
financial markets by providing indirect fiscal support for crisis countries. The ECB
is also using “unconventional monetary policy” to buy time for politicians. Now the
European Stability Mechanism (ESM), which will take effect earlier than planned,
will need more resources to improve its short-term crisis management capabilities.
 The global economic picture varies, with slightly stronger development in the US, a
slowdown in emerging countries and considerable sluggishness in Europe. We
expect politicians to follow the lead of the central banks and introduce
“unconventional fiscal policy” in an attempt to strengthen demand, despite a lack
of true fiscal muscle.
Euro countries have agreed on fiscal pact
Agreement on a fiscal pact in the EU with binding
rules for the euro countries will improve budget
discipline. This is overdue – critical really – for the
euro zone. Twenty-five EU countries support the
pact, with the UK and Czech Republic refusing.
Now the emphasis can shift to growth and
competitiveness. Moreover, the size of the
European Stability Mechanism (ESM) must be
determined. It is positive that the ESM has been
moved up to July, but if it isn't given more resources
it won't be able to resolve the current crisis in euro
zone.
There are growing concerns that Portugal will need
a new rescue package. The interest rate on its 10year government bond has risen substantially and
now exceeds 17%. One reason is its credit
downgrade to junk status. Another is the concern
that private lenders will have to accept haircuts in
the future in spite of the fact that politicians have
claimed that Private Sector Involvement (PSI)
would be limited to Greece.
Those who today claim that the euro zone has
restored financial stability thanks to the measures
taken by the European Central Bank (ECB) are
forgetting that the crisis could quickly escalate
again if the fears of a Greek default return or if
Portugal needs a rescue package at the same time
that Italy and Spain lose the financial market’s
confidence that they are moving in the right
direction. The ECB’s 1% loans to banks have been
successful so far, since credit austerity is easing,
banks can now better finance themselves with less
collateral and they are buying government bonds
from crisis countries, alleviating the sovereign debt
concerns in these countries. It probably would have
been harder for the ECB to provide such substantial
support if the fiscal pact hadn't been signed. Even if
this pact does not resolve the short-term crisis and
Economic Research Department, Swedbank AB (publ), SE-105 34 Stockholm, tel +46-8-5859 7740
E-mail: [email protected] Internet: www.swedbank.com Responsible publisher: Cecilia Hermansson, +46-85859 7720, Magnus Alvesson, +46-8-5859 3341, Jörgen Kennemar, +46-8-5859 7730, ISSN 1103-4897
The Global Economy
Monthly newsletter from Swedbank’s Economic Research Department, continued
No. 1 • 31 January 2012
merely lays a foundation for longer-term stability, it
opens the door to better crisis management by
strengthening the ECB’s confidence in the political
situation. At the ECB’s next auction on 29 February,
banks will borrow significantly more than they have
to date: 489 billion euro. This time we could be
talking about loans of up to 1 trillion euro. In other
words, the ECB has also resorted to quantitative
easing game – but through the back door.
more than 2% in the next year given the many
challenges from the domestic economy and the
slowing economy in the rest of the world, especially
Europe. In his State of the Union address last week,
President Barack Obama argued that the US
economy is headed in the right direction. The
economy is also the biggest election issue, which
may help Mitt Romney, who is expected to win
today’s Republican primary in Florida.
Split global economy
US savings ratio and debt ratio (%)
The US economy has rebounded slightly of late,
while in Europe the opposite is true. Many emerging
countries are also seeing a slowdown.
GDP growth (%)
In Europe, fourth quarter results are still not
available for many countries. The UK’s GDP slipped
0.2% from the previous quarter, meaning that GDP
for 2011 rose by a modest 0.9%. Worries about a
recession have risen. It was manufacturing industry
that contributed to the slowdown during the fourth
quarter, at the same time that the service sector
stagnated. Our forecast of GDP growth of 0.5% in
2012 includes lower demand due to the fiscal
austerity.
Although the US preliminarily reported stronger
growth during the fourth quarter (2.8% at an annual
rate) than the previous two quarters, the increase
was fragile for several reasons. First, inventory
investment contributed 1.9 percentage points, and
is unlikely to continue in coming quarters. Secondly,
there has been a decline in domestic demand in
terms of both spending and investment. The
savings ratio has fallen, and there is a risk that
consumer spending will be relatively weak once
savings are restored. Thirdly, net exports didn't
contribute. What’s more, the public sector remains
a drag on growth, which will probably continue as
well in coming quarters. The improvement in the
labour market in December is far from sustainable
either, since the lower unemployment is largely the
result of temporary jobs and a shrinking labour
supply.
In the euro zone, GDP is estimated to have fallen in
most countries in the fourth quarter. This is
especially true of crisis countries like Spain,
Greece, Portugal and even Italy, but also France
and Germany. Our forecast is for a recession in the
euro zone in 2012.
China reported that its GDP during the fourth
quarter grew by 8.9% at an annual rate. In the
same quarter of 2010 growth was 9.8%. The rate
has gradually slowed, and the government is trying
to ensure a soft landing. The housing market and
construction sector are concerns, however, as are
slowing exports. In December housing starts fell by
20% on an annual basis, a trend that could have
serious effects on both the local and national
economy if it continues.
Some glimmers of light have been seen in the
housing market, but the gains in construction are
from very low levels. Housing sales are still falling,
and are now nearly 80% below their 2005 peak.
Unconventional economic policies gain
prominence
The US economy is slowly moving in the right
direction. GDP growth was 1.5% on an annual
basis during the last quarter of 2011 and for the fullyear reached 1.7%, a rate that is unlikely to rise to
Slow growth in many parts of the world at the same
time the US recovery continues, but in low gear,
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The Global Economy
Monthly newsletter from Swedbank’s Economic Research Department, continued
No. 1 • 31 January 2012
sheets by saving, the news isn’t so good, since the
positive effects on the stock market aren't
necessarily sustainable, at the same time that other
forms of savings don’t offer much return.
has led to calls for more expansive economic
policy.
The problem is that economic policy now has less
impact (monetary policy) and offers less chance of
success due to austerity needs (fiscal policy). This
increases the need for unconventional economic
policy. The UK, Japan and the US are likely to
resort to more unconventional monetary policy, as
is the ECB, though indirectly.
The effectiveness of QE3 is questionable as well.
Research (see Swedbank’s Analysis from 26
October 2010) has shown that QE1 had a positive
effect on interest rates, though the same results for
QE2 cannot be determined. It is possible that these
measures will stop having much effect on margins,
at the same time that the negative effects of higher
commodity prices and capital flows to emerging
countries can’t be overlooked either.
Central banks’ benchmark rates (%)
In the US, there is growing talk of resorting to
unconventional fiscal policy. The need for new
measures is being discussed for countries with
large debts, large austerity needs and a large risk of
falling into a liquidity trap. Paul Krugman is among
those who feel that the multiplier is high under such
circumstances and that there is good reason for
more fiscal policy measures to stimulate demand.
Emmanuel Fahri from Harvard University is the coauthor of a paper entitled “Unconventional Fiscal
Policy at the Zero Bound”, which has brought up the
possibility of raising inflation (for countries at risk of
deflation) through a higher VAT while at the same
time cutting income taxes to strengthen the labour
market. This is in line with what President Sarkozy
is proposing in France, but the criticism there is that
there is a risk consumer demand will fall too much if
the VAT is raised. In the absence of fiscal muscle,
we can expect to see an array of ideas for
unconventional fiscal measures.
The US is trying to put together (or perhaps avoid)
a new package of quantitative easing by
announcing that its benchmark rate will remain very
low for an extended period. The most recent FOMC
meeting announced that the fed funds rate will stay
near zero (Zero Interest Rate Policy, ZIRP) through
2014. A new quantitative easing package (QE3)
can’t be ruled out if inflation falls below the recently
defined target of 2% or if the labour market
underperforms. In that case the Federal Reserve
could buy mortgage bonds to keep further pressure
on mortgage rates.
Cecilia Hermansson
It is uncertain whether the central bank’s
announcement will be effective. If anything, it
should raise concerns that the economy is in such
bad shape that ZIRP will be needed for another
three years. Confidence could be hurt as a result.
For households that need to restore their balance
Swedbank
Economic Research Department
SE-105 34 Stockholm, Sweden
Phone +46-8-5859 7740
[email protected]
www.swedbank.se
Legally responsible publisher
Cecilia Hermansson, +46-88-5859 7720.
Swedbank’s monthly The Global Economy newsletter is published as a service to our
customers. We believe that we have used reliable sources and methods in the preparation
of the analyses reported in this publication. However, we cannot guarantee the accuracy or
completeness of the report and cannot be held responsible for any error or omission in the
underlying material or its use. Readers are encouraged to base any (investment) decisions
on other material as well. Neither Swedbank nor its employees may be held responsible for
losses or damages, direct or indirect, owing to any errors or omissions in Swedbank’s
monthly The Global Economy newsletter.
Magnus Alvesson, +46-8-5859 3341
Jörgen Kennemar, +46-8-5859 7730
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