The Euro area is facing contagion from the US bond market reacting to the Biden plan in the form of higher real rates. Now, some overheating in the US may be in the ECB’s interest if it triggers some Euro depreciation 1/6 What happens if the Fed opts for “quick tapering” and US 10y yields go to 3% by 2022? In our model this would take the Euro down 10% against the dollar after 1y relative to the ECB’s baseline. That could bring EA inflation to 1.9% in 2023 from 1.4% in baseline 2/6

Fabio Panetta’s speech could well be the beginning of the ECB’s response to the Fed’s Average Inflation Targeting - assuming it is embraced by the rest of the Governing Council 1/9 The Fed’s move is based on the notion that it is easier to allow inflation to overshoot in the future amid decent cyclical conditions than to lift infla amid bad cyclical conditions. A pledge to overshoot tomorrow is thus credible and could lift inflation expectations today 2/9

It’s a swoosh! The global data flow continues to point upward but the pace of normalisation is slowing down. See for instance the deceleration in US private payroll growth and retreat in Euro area PMIs (although still in expansion territory 1/8 This calls for policy support beyond the emergency packages. The French recovery plan participates to this. But at the same time we are surprised by fiscally disciplinarian noises emerging here and there 2/8

It’s always pleasing to see the British Eurosceptic press defeated again: habemus RRF deal! Rumours of the EU’s death were exaggerated as usual 😊 1/8 Now, on substance, the signals are very positive. The taboo of debt mutualisation is broken. Financial solidarity that does not saddle recipients with more debt is an important political moment 2/8

The pandemic acceleration/stimulus debate loop has started again in the US. Real-time data is starting to reflect a relapse in activity. Pumping up more pent-up household demand may not be the solution though 1/11 The HEROES act passed by the House in May legislates for an even more generous “check” to households (4800 USD for a family of 4 instead of 3400). D.Trump signalled openness to make it even bigger 2/11

Assuming our economies continue to normalise fairly swiftly (which in Europe remains the likely scenario) fiscal policy should shift from emergency “carpet bombing” offsetting the collapse in supply to long-haul demand management 1/11 However industries/businesses were not equal in the face of the lockdown and some of them will need specific protection for long. This is triggering a debate on over-protection/zombification. We think however that sectoral support is part of demand management. 2/11

A 1% decline in GDP triggers a 6% rise in the non-performing loans ratio. This matters for the public debt trajectory given the size of the loan guarantees offered to deal with the pandemic in some countries 1/9 In the case of Italy, the impact of the ongoing recession would be consistent with 13% of loans turning “delinquent”. With an average guarantee of 80% if all the envelope is used, this could add another 2.5% of GDP to the deficit 2/9

Thinking about medium-term effects of the crisis. So far the acceleration in money supply is offset by collapsed velocity of money. What happens when velocity normalises, as per C. Goodhart’s point in VOX? 1/11 2/3 of the current growth in M3 in EZ comes from credit to private sector, 1/3 from credit to the government. Good news is that there is no crowding out: MFIs lend to businesses and buy govies at the same time 2/11

The market may be confusing a mechanical rebound in output, as supply begins to be “freed up” by the relaxation in the lockdown, with a sustained recovery 1/9 Beyond the statistical measurement issues this is what the positive US payroll number reflected last week: 1.2 mn rehirings in hospitality as it reopens. We will see similar moves in Europe 2/9

With the benefit of more days to pore over the docs, another look at the EC’s “Next Generation” package 1/14 The political signal is powerful. On the macro side though it is a hybrid animal. It looks more like a much magnified medium term cohesion fund than as a recession busting instrument 2/14

We could read the EC proposals across two axes: 1/ grants versus loans and 2/ tax resources versus state contribution. A thread 1/9 On 1/ communicating on 750bn helps VDL minimising the share of grants, which may help with the frugals. There is a majority of grants in the “Recovery and Resilience”
Fund (310bn/560bn). And the cohesion fund top up (55bn) is also grants i think ...2/9

The debt cancellation debate is rife. I find it is often misleading because it does not consider the time dimension. As long as the central bank holds the gov bonds, the gov pays interest to itself. Cancelling is useless (see @agnesbq1 for robust illustration). 1/7 The issue becomes more complicated when the CB stops buying and then offloads its bonds back to the market. Then liquidity falls (CB absorbs cash) and the gov must refinance its debt at a higher cost and stops paying interest to itself 2/7

The Franco-German initiative changes the dynamic to some extent but the ECB still needs to consider the PEPP quantum 1/7 At the daily pace of purchases of 34bn of the week ending 8 May the 750bn would be spent by the end of the summer. Hopefully purchases could slow down but peripheral markets are likely to be volatile if the negotiations around the recovery fund get noisy 2/7

[sorry full thread now] the Franco-German proposal is a proper breakthrough. Crucial for the negotiations will be the difference between the expenditure key and the repayment key 1/6 For simplicity let’s first assume that each country’s “pandemic status” is the basis for the expenditure key. Italy has 20% of all covid cases in the EU. Their share in EU GDP stands at 12.8% (repayment key). Italy would be a net recipient for 2% of its GDP 2/6

Weekly views thread. The notion of proportionality is particularly problematic for the ECB because the Treaty de facto makes monetary policy “disproportionate” 1/9 Indeed, if the ECB can support the other objectives of the EU only if it is without prejudice of the price stability goal (article 127 TFEU), it suggests that it trumps ANY other consideration 2/9

Some more musings on the GCC ruling. Might be handy to distinguish two interconnected issues: a) how to deal with it within the German institutional system and b) how to do the same at the EU level. 1/4 A) Within the German system, the GCC put the bar very high since point 235 of its ruling calls for another decision by the ECB (h/t O. Rakau). So not obvious merely having the Federal Gov + Bundestag certifying proportionality ex-post would be enough 2/4

Since constitutional judges opine on the impact of monetary policy, it’s probably OK for economists to continue pondering on the legal ramifications of GCC 1/9 Let’s assume the ECB refuses to submit itself to the GCC’s “invitation” to justify itself on proportionality, then Buba permanently stops. Defining how they would continue without Buba gets interesting 2/9

I can’t miss the “I am not a lawyer but” party. So: art 260 of the Treaty: “if the commission considers that the member state has not taken the necessary measures to comply with the judgment of the Court, it may bring the case before the Court (...) it shall specify ...1/5 ...the amount of the (...) penalty payment to be paid by the Member State 2/5

In the current ocean of depressing news, it is reassuring to see that the “banking channel” of monetary transmission seems to be working in the EA 1/12 Flows of new loans to firms in March were the highest on record. This in itself is not surprising but there does not seem to be any strong evidence of supply-side crédit rationing 2/12

The US economic dependence on oil adds to the divergence with Europe. WTI close to zero would cost nearly half a point of GDP in the US through lower oil-related capex 1/10 But the biggest issue pertains to financial stability. Energy-related names account for 15% of the US high-yield market, and their spread is twice as wide as the average 2/10

To assess the support package negotiated at the Eurogroup last week it may make sense to start from the financial position of the most fragile member states 1/12 Between the mechanical impact of the recession on the cyclical balance and the discretionary stimulus the Italian deficit is likely to be close to 10% of GDP and public debt >150% of GDP 2/12