Reducing uncertainty to facilitate economic recovery

Elliot Aurissergues (Economist at the OFCE)

As the health constraints caused by the pandemic continue to weigh on the economy in 2021, the challenge is to get GDP and employment quickly back to their pre-crisis levels. However, companies’ uncertainty about their levels of activity and profits in the coming years could slow the recovery. In order to cope with the possible long-term negative effects of the crisis, and weakened by their losses in 2020, companies may seek to restore or even increase their margins, which could result in numerous restructurings and job losses. Economic recovery could take place faster if business has real visibility beyond 2021. While it is difficult for the current government to make strong commitments, on the other hand mechanisms that in the long term are not very costly for the public purse could make it possible to take action.

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Dispersion of company markups internationally

Stéphane Auray and AurélienEyquem

The strong globalization of economies has increased interest in the importance of markups for companies with an international orientation. A markup is defined as the difference between the marginal cost of production and the selling price. Empirical evidence is accumulating to show that these markups have increased significantly in recent years (Autor, Dorn, Katz, Patterson, and Reenen, 2017; Loecker, Eeckhout, and Unger, 2020) and that large corporations account for a growing share of the aggregate fluctuations (Gabaix, 2011). Moreover, the dispersion of markups is considered in the literature as a potential source of a misallocation of resources – capital and labour – in both economies considered to be closed to international trade (see Restuccia and Rogerson, 2008, or Baqaee and Farhi, 2020) and economies considered to be open to trade (Holmes, Hsu and Lee, 2014, or Edmond, Midrigan and Xu, 2015). Finally, it has recently been shown by Gaubert and Itskhoki (2020) that these markups are a key determinant of the granular origin – i.e. linked to the activity of big exporters – of comparative advantages, or in other words, they may be a determinant of trade competitiveness.

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What factors drove the rise in euro zone public debt from 1999 to 2019?

by Pierre Aldama

Between 1999 and 2019, the eve of the Covid-19 pandemic, the public debts of the 11 oldest euro zone members had risen by an average of 20 percentage points of GDP. This increase in public debt is commonly attributed to structural budget deficits, particularly those in the pre-crisis period and in the “South”. But how much of the stock of public debt in 2019 can be attributed to structural deficits, and how much to GDP growth, interest payments or cyclical deficits? In this post, we use the December 2020 edition of the OECD’s Economic Outlook to break down the changes in public debt into its main factors: structural and cyclical primary balances, the interest burden, nominal GDP growth and stock-flow adjustments. This shows that the structural deficits generally contributed less than is commonly assumed, and that the increase in public debt over the period was largely the result of the direct and indirect consequences of the double-dip recession in the euro zone.

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Monetary Policy During the Pandemic: Fit for Purpose?

Christophe Blot, Caroline Bozou and Jérôme Creel

In a recent Monetary Dialogue Paper for the European Parliament, we review and assess the different policy measures introduced by the ECB since the inception of the COVID-19 crisis in Europe, mainly the extension of Asset Purchase Programme (APP) measures and the development of Pandemic Emergency Purchase Programme (PEPP) measures.

APP and PEPP have had distinct objectives in comparison with former policies. APP has been oriented towards price stability while PEPP has been oriented towards the mitigation of financial fragmentation.

To this end, we start by analysing the effects of APP announcements (including asset purchase flows) on inflation expectations via an event-study approach. We show that they have helped steer expectations upward.

Then, we analyse the impact of PEPP on sovereign spreads and show that PEPP has had heterogeneous effects that have alleviated fragmentation risk: PEPP has had an impact on the sovereign spreads of the most fragile economies during the pandemic (e.g. Italy) and no impact on the least fragile (e.g. the Netherlands). However, sovereign spreads have not completely vanished, making monetary policy transmission not fully homogeneous across countries.

On a broader perspective, we also show that overall macroeconomic effects have been in line with expected outcomes since the mid-2000s: ECB monetary policy measures have had real effects on euro area unemployment rates, nominal effects on inflation rates and financial effects on banking stability. These results are in line with recent estimates at Banque de France (Lhuissier and Nguyen, 2021).

As a conclusion, an increase in the size of the PEPP program, as recently decided by the ECB, will be useful if financial risks re-emerge. Meanwhile, we argue that an ECB decision to cap the sovereign spreads during the COVID-19 crisis would alleviate the crisis burden on the most fragile economies in the euro area, where sovereign spreads remain the highest.

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Spain: Beyond the economic and social crisis, opportunities to be seized

by Christine Rifflart

Spain has been hit hard in 2020 by the Covid-19 health crisis, which the authorities are struggling to control, accompanied by an economic recession that is one of the most violent in the world (GDP fell by 11% over the year according to the INE)[1]. The country’s unemployment rate reached 16.1% at the end of last year, a rise of 2.3 points over the year despite the implementation of short-time work measures. The public deficit could exceed 10% of GDP in 2020, and the public debt could approach 120% according to the Bank of Spain’s January 2021 forecasts. Europe has enacted large-scale support programmes for affected countries, and as one of these Spain will be the country receiving the most EU-level aid. It will benefit from at least 140 billion euros, with 80 billion of that (i.e. 6.4% of 2019 GDP) taking the form of direct transfers through the NextGenerationEU programme.

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Public debt: Central banks to the rescue?

By Christophe Blot and Paul Hubert

In response to the health and economic crisis, governments have implemented numerous emergency measures that have pushed public debt up steeply. They have nevertheless not experienced any real difficulty in financing these massive new issues: despite record levels of public debt, the cost has fallen sharply (see Plus ou moins de dette publique en France ?, by Xavier Ragot). This trend is the result of structural factors related to an abundance of savings globally and to strong demand for secure liquid assets, characteristics that are generally met by government securities. The trend is also related to the securities purchasing programmes of the central banks, which have been stepped up since the outbreak of the pandemic. For the year 2020 as a whole, the European Central Bank acquired nearly 800 billion euros worth of securities issued by the governments of the euro zone countries. In these circumstances, the central banks are holding an increasingly high fraction of the debt stock, leading to a de facto coordination of monetary and fiscal policies.

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Waiting for the recovery in the US

By Christophe Blot

As with the economic performance of all the industrialized countries, economic activity fell off sharply in the second quarter of 2020 across the Atlantic before rebounding just as sharply the following quarter. The management of the crisis in the US is largely in the hands of the different States, and the election of Joe Biden should not change this framework since he declared on November 19 that he would not order a national lockdown. However, the health situation is continuing to deteriorate, with more than 200,000 new Covid-19 cases per day on average since the beginning of December. As a result, many States are adopting more restrictive prophylactic measures, although without returning to a lockdown like the one in the Spring. This situation could dampen economic prospects for the end of the year and also for the start of the mandate of the new President elected in November. Above all, it makes it even more necessary to implement a new recovery plan, which was delayed by the election.

As in the euro zone, recovery in the US kicked off as soon as the lockdown was lifted. GDP grew by 7.4% in the third quarter after falling by 9% in the previous quarter. Compared with the level of activity at the end of 2019, the economic downturn amounted to 3.5 points, versus 4.4 points in the euro zone. The labour market situation also improved rapidly, with the unemployment rate falling by 8 points, according to data from the Bureau of Labor Statistics for November, from its April peak of 14.7%. These results are the logical consequence of the lifting of restrictions but also of the large-scale stimulus plans approved in March and April, which have massively absorbed the loss of income for households and to a lesser extent for US companies (see here). However, the upturn in consumption is still being dampened by some ongoing restrictions, particularly in sectors with strong social interactions, where spending is still nearly 25% lower than it was in the fourth quarter of 2019 (Figure 1). As for the consumption of goods, it has been much less affected by the crisis and is down only 12% from its pre-crisis level for durable goods and 4.4% for non-durable goods. Nevertheless, most of these support measures have come to an end, and as of this writing the discussions that began in late summer in Congress have not yet led to an agreement between Republicans and Democrats. Despite the rebound, the health impact of the pandemic and the economic consequences of the lockdown on the labour market require a discretionary policy in a country where the automatic stabilizers are generally considered to be weaker[1]. New support measures will be all the more necessary as a further tightening of restrictions is looming and the recovery seem to be running out of steam. The initial consumption figures for the month of October point to a fall in the consumption of services, and employment also stabilized in November, remaining well below its level at the end of 2019.

However, after the setback of the discussions in Congress, it will now be necessary to wait until the first quarter of 2021 for a new support plan to be approved and for a possible reorientation of US fiscal policy after Joe Biden’s victory. In the Autumn, the Democrats proposed a 2 trillion dollar (9.5 GDP points) package, almost as much as the 2.4 trillion dollar (10.6 GDP points) package adopted in March-April 2020[2]. The aid would, among other things, support the purchasing power of the unemployed through an additional federal payment. Although unemployment is much lower than in the second quarter, it remains above its pre-crisis level and is now characterized by an increase in long-term unemployment for which there is generally no compensation. In November, the share of those who had been unemployed for at least 27 weeks was 37 per cent (or 3.9 million people, Figure 2), and the median duration of unemployment had risen from 9 weeks at the end of 2019 to almost 19 weeks in November 2020. In addition, States whose tax revenues have decreased with the crisis could benefit from a federal transfer, thereby avoiding spending cuts[3].

However, despite the end of the suspense over the outcome of the presidential elections, the political and economic uncertainty has not been completely resolved. Indeed, it will not be known until early January whether the Democrats will also have a majority in Congress. They have certainly kept the House of Representatives, but it will be necessary to wait until the beginning of January for the Senate, with a ballot planned in Georgia that will determine the political colour of the last two seats [4]. Both seats are now held by Republican senators. However, Joe Biden won Georgia by 0.2 points against Donald Trump, the first victory in the State for a Democratic candidate since 1992. With both State-wide senatorial elections to be contested directly, the results are likely to be close.  If one of the Democratic candidates is defeated, Joe Biden will be forced to contend with the opposition. But, as Paul Krugman points out, the Republicans are generally more inclined, once in opposition, to promote austerity. This is reflected in the uncertainty indicators of Bloom, Baker and Davies, whose economic policy uncertainty rose in November (Figure 3). This uncertainty is certainly lower than in the Spring but remains higher than that observed between 2016 and 2019. During this period, growth could weaken, and then a strong recovery is likely to be followed by more subdued growth, which will have repercussions on the labour market. Regardless of the outcome, a plan will likely be approved in the first quarter of 2021, but its adoption could take longer if it is conditional on an agreement between Republicans and Democrats in Congress. However, this could be lengthy given the urgency of the health and social crisis, and could plunge a significant proportion of the most vulnerable into poverty.

Source : Baker, Bloom & Davis. https://www.policyuncertainty.com/index.html


[1] See for example Dolls, M., Fuest, C. & Peichl, A., 2012, “Automatic stabilizers and economic crisis: US vs. Europe”, Journal of Public Economics, 96(3-4), pp. 279-294.

[2] By comparison, the European programmes are weaker, ranging from 2.6 GDP points for France to 7.2 points for the UK.

[3] Note that the States generally have fiscal rules limiting their capacity to run a deficit.

[4] Of the 100 seats in the Senate, the Republicans already hold 50. In the event of a tie between the two parties, it is the voice of the Vice-President-elect Kamala Harris that will decide between them. A single victory in Georgia would therefore allow the Republicans to retain the majority.

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Europe/US: How has fiscal policy supported income?

By Christophe BlotMagali Dauvin and Raul Sampognaro

The sharp fall in activity and its brutal social consequences have led governments and central banks to enact ambitious support measures to cushion the shock, which resulted in an unprecedented global recession in the first half of 2020, as discussed in Policy Brief 78 . Faced with a health crisis that is unprecedented in contemporary history, requiring forced shutdowns to curb the spread of the virus, governments have taken urgent measures to prevent the onset of an uncontrolled crisis that could permanently alter the economic trajectory. Three main types of measures have been taken: some aim to maintain consumer purchasing power in the face of the shutdowns; others seek to preserve the production system by targeting business; and some are specific to the health sector. The quarterly national accounts, available at the end of the first half of the year, provide an update on the extent to which the disposable income of private agents has been preserved by fiscal policy at this stage of the Covid-19 crisis [2].

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What more could the central banks do to deal with the crisis?

By Christophe Blot and Paul Hubert

The return of new lockdown measures in numerous countries is expected to slow the pace of economic recovery and even lead to another downturn in activity towards the end of the year. To address this risk, governments are announcing new support measures that in some cases supplement the stimulus plans enacted in the autumn. No additional monetary policy measures have yet been announced. But with rates close to or at 0% and with a massive bond purchase policy, one wonders whether the central banks still have any manoeuvring room. In practice, they could continue QE programmes and increase the volume of asset purchases. But other options are also conceivable, such as monetizing the public debt.

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Europe’s recovery plan: Watch out for inconsistency!

by Jérôme Creel (OFCE & ESCP Business School) [1]

On 27 May, the European Commission proposed the creation of a new financial instrument, Next Generation EU, endowed with 750 billion euros. The plan rests on several pillars, and will notably be accompanied by a new scheme to promote the revival of activity in the countries hit hardest by the coronavirus crisis. It comes on top of the Pandemic Crisis Support adopted by the European Council in April 2020. A new programme called the Recovery and Resilience Facility will have firepower of 560 billion euros, roughly the same amount as the Pandemic Crisis Support. The Recovery and Resilience Facility stands out, however, for two reasons: first, by the fact that part of its budget will go to grants rather than loans; and second, by its much longer time horizon.

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