Saturday, 29 April 2017

Germany's trade unions and its export surplus: Streeck's mistake

In the latest LRB, Wolfgang Streeck asserts the following:
German prosperity has depended historically on the export of manufactured goods and, later, the non-export of manufacturing jobs. Appeals to German unions to help rectify the obscene trade imbalance between Germany and other euro countries – by demanding higher wages and thereby raising unit labour costs – therefore fall on deaf ears. For the unions the euro is an ideal solution to the employment problem that hit them in the 1990s with the return of price competition and the internationalisation of production. Monetary union gives German manufacturing a captive market in Europe, as well as an edge over European competitors that have to operate in more inflationary institutional settings. On top of that, it equips German firms with an undervalued currency in markets outside the Eurozone, especially at a time when the ECB’s quantitative easing keeps pumping up the bloc’s money supply. To restrain the competitiveness of German industries in order to save the single currency, as outsiders sometimes suggest, would from the perspective of the unions be committing suicide for fear of death. It would also break up their alliance with employers and the government, held together no longer by trade union power but by the constraints and opportunities of the Eurozone. And it isn’t only the unions for whom the competitiveness of German manufacturing is of paramount importance. Their priorities are shared by the government, currently a grand coalition of the centre-right, representing industry, and the centre-left, where the SPD is basically the political arm of IG Metall. 
While I quail a bit at contradicting a German leftist regarding German unions, the publicly available evidence suggests this is flatly wrong.  German unions would be very happy to see increased wages as part of a package to reduce the export surplus.  In fact, just yesterday the website of the German Trade Union Confederation (DGB), an organisation including the aforementioned pre-eminent German union IG Metall, had this to say:
Export surplus: We need more domestic demand!
Strengthen purchasing power, support imports 
[Despite its claims to the contrary] the German government can and must act: It can dry up the low-wage sector and support centralised wage bargaining [Tarifbindung] and thus contribute to ensuring that employees here have more money to demand products.  This supports imports and pushes enterprises to invest more domestically for a growing market.
Similarly, an economics think-tank that's part of the DGB-affiliated Hans-Bockler-Stiftung recently argued that the best policy against the export surplus would combine higher wages with increased government spending for investment purposes.

Hmm, maybe an exception? How about this, from a 2010 IG Metall analysis (page 12):
German wage policy has European responsibilities. In the sectors which in the past lagged behind, we need further wage rises that make use of the room for manoeuvre in distribution...
There's no doubt that German unions supports a high-value-added industrial model that relies on substantial exports. But the idea that they reject wage rises that would permit these exports to be matched better by substantial imports is just wrong. 

One could say a lot more about the wrong-headed supply-side economics in Streeck's piece, but it's certainly clear that German unions don't share this viewpoint.


Just one more piece of evidence, from the report adopted by the 485 delegates to IG Metall's 2015 congress ("Gewerkschaftstag"), as an authoritative a statement of official union policy as I can find (pp. 77-78):
The economy based essentially on exports exacerbates the trade imbalances in Europe. In Germany the unit wage costs over the last 15 years have risen much less than in other European countries. This leads to export surpluses, while other other countries are forced to finance their demand through credit. ...
Our struggle for a better Europe also means supporting the struggles for higher wages and against precarious employment domestically. Success in the struggle against the extremely unjust distribution domestically will help people in all of Europe. 

Wednesday, 5 October 2016

Constitutions, Credible Commitment, and Brexit

In a famous paper, North and Weingast linked the security of property rights to constitutional government. They argue that the 17th century Glorious Revolution in England created a “credible commitment” by the English state to property rights by giving property owners’ Parliamentary representatives a veto over legal changes infringing those rights. 

For this argument, it is an embarrassing circumstance that the separation of powers between Crown and Parliament N&W described was a transient feature of English and later British institutions. Once the monarch’s role dwindled to a mere formality, the UK’s government was characterised by a hyper-centralisation of power in the Prime Minister and the ruling party, a centralisation usually known as the “Westminster model.” Especially given the absence of a formal written constitution, a British PM has extraordinary scope for discretionary action, including action damaging to property rights. The N&W argument would imply that this lack of constitutional constraint should undermine property rights, which on the contrary are generally seen as being quite secure in Britain.

The Brexit referendum and associated policy initiatives recently announced, however, go some way to rehabilitating the importance of the causal mechanism North and Weingast proposed.  N&W argued that when English property owners became secure in their rights, they were more willing to invest. The causal pathway runs from constitutional constraint to the ability to rely on a stable institutional framework, and thence to the readiness to make investments. Now, property rights don’t have to be conceived narrowly as the sort of rights explicitly specified in legal title or contractual arrangements.  In fact, an ancient common-law doctrine (known as “promissory estoppel” or “reasonable reliance”) suggests that someone who has undertaken costly actions while relying on another’s promise is entitled to legally enforced compensation if that promise is violated.

The Brexit campaign, and especially its aftermath, have shone a spotlight on many such promises made by the British state that it now proposes to violate. Immigrants from the EU, for instance, relied on the assumption they would have freedom of movement and that it made sense to pursue a career (for instance in academia or the medical profession) within Britain. Prospective university students around the world invested time, effort, and often money in study choices premised on the prospect of admission to British universities and the possibility of working here after graduation. Corporations sited operations in the UK, relying on its integration with the EU and access to the EU’s single market. Some people in Northern Ireland probably acquiesced in continued British rule because they relied on membership of the EU rendering the internal Irish border less significant.    

From the perspective of the doctrine of reasonable reliance, all these groups are having ‘property rights’ expropriated. And this is an expropriation facilitated precisely by the Westminster model and the absence of a written constitution. It was the Westminster model that made the calling of a referendum with such profound constitutional significance subject only to the internal decision of the Conservative majority in Parliament. The continuing relevance of limited constitutional constraints is shown vividly in discussions about the role of Scotland or the claim that the Government can rely on “royal prerogative” to invoke Article 50 to leave the EU without Parliamentary approval. With no-one constitutionally empowered to veto them, the Conservatives can act at will to shred what the morality embedded in common law (and what could be more English than that?) would unambiguously regard as property rights—just the sort of scenario North and Weingast describe.

One of the central arguments N&W make is that for absolute monarchs, a reputation for protecting property rights is an inadequate substitute for constitutional constraint, since monarchs’ royal prerogative always includes changing their minds. A reputation, though, is better than nothing. There’s probably little hope that the Tories will recognize how particularly dangerous it is for a government with so much legal discretion to display such contempt for promises on which so many have relied.  


Some lawyers and scholars think the present Government’s beliefs about the scope of its legal discretion are mistaken. Many interesting arguments about the bearing of the UK (unwritten) constitution on Brexit’s admissibility can be found here.

Joseph Singer wrote a great article seeking to extend the notion of property rights building on the idea of reliance.

Sunday, 25 September 2016

Independent central banks, democracy, and Skcolidlog

Goldilocks’ ideal porridge, you may recall, was neither too hot nor too cold, but rather just right. A lot of people think this ideal has been reached in the relationship between central banks and democracy. The operational autonomy of central banks’ personnel and policy ensures there’s not too much democracy, while the ultimate authority of elected officials over personnel selection and policy goals mean there’s not too little democracy either. Just right? 

Not at all, I argue in this post. Experience demonstrates that the ‘operational independence in pursuit of democratically established goals’ formula creates fundamental and disruptive tensions in democratic polities (including and especially the EU/Eurozone, which I class among them). These tensions primarily affect the coordination of fiscal policy and monetary policy. And instead of Goldilocks, we have Skcolidlog: either central banks have too much power to dictate fiscal policy, or too little.

That the ECB enjoyed from early 2010 through the middle of 2012 an influence on Eurozone fiscal policy so immoderate as to fundamentally contradict democracy is a point I have argued before (and at length here). The ECB threat that government bond markets would be abandoned to self-fulfilling market perceptions of fiscal collapse compelled many governments to moderate or reverse programmes of fiscal stimulus and overrode electoral politics.

But lately, the shoe may seem to be on the other foot. Consider this exchange at Draghi’s September 2016 press conference
Question: You've been urging governments to act for some time, and I'm wondering if there's a sense that maybe they might now be a little more willing to act and that the ECB could encourage that willingness by not raising excessive expectations about future monetary policy measures, hence the tone today.
Draghi: The ECB can't be in a sort of – let me say, what the ECB can do is to basically flag what is needed for monetary policy to be even more effective than it is at the present time.
In effect, the journalist asked whether Draghi could threaten to limit monetary stimulus in order to compel action by the fiscal authorities, probably hinting toward further fiscal stimulus. Draghi replied that he had only verbal persuasion at his disposal. (Draghi went on to demonstrate once again how low fiscal stimulus is on his list of priorities, but that is beside the point for now). 

While ECB leaders’ protestations of their limited influence in promoting austerity are unconvincing, Draghi’s assertion that in present circumstances he has little leverage on policy is far more believable. The difference between the two situations turns on the nature of the ECB’s mandate. When amidst the government bond market panics of 2010-2012 it was the ECB’s readiness to play a lender of last resort role that was the axis of contention, it was a plausible assertion that this role lay outside the ECB’s mandate. This was one reason a threat to permit bond-market meltdowns was credible. But in the present situation, where the ECB is dramatically failing to meet its clearly specified mandate to attain price stability (which it has defined as inflation ‘close to, but below 2% per year’), it has almost no flexibility: no matter how unhelpful fiscal policy is, the ECB must continue to stimulate, including via policies many find extreme, such as negative interest rates and a massive quantitative easing programme. The ECB has no threat to deploy.

Thus, the discretion created by the lack of a clear mandate to play a lender-of-last-resort role left the ECB with ‘too much’ power, but the presence of such a clear mandate in the case of fighting deflation left it with ‘too little’, at least from the perspective of those who believe further fiscal stimulus is urgently necessary.  

That a Goldilocksian balance remains elusive is not just an idiosyncratic result of current economic conditions. In fact, we are faced with a quite general limitation of the the present formula for reconciling democracy with independent central banking. Lorenzo Bin Smaghi recently likened the situation now facing central banks, in which they must soldier on despite a lack of supportive fiscal policy, to that facing central banks in the 1970s and early 1980s, when the challenge was inflation, not deflation. Most notoriously, Reagan’s budget deficits in the face of the inflation of the early 1980s pushed Fed chair Paul Volcker to maintain extremely high interest rates. In both cases, central bank policy in service of a price-stability mandate had to go to extremes to compensate for unsupportive fiscal policy. 

A very simple game-theoretic analysis (which builds on Blinder’s 1982 discussion of the Reagan-Volcker episode) helps to illustrate the generality of the Skcolidlog pattern in central bank-fiscal authority relations. The diagram above depicts policy choices by fiscal authorities followed by policy choices by central bankers. What it means to ‘reinforce market trends’ is contextual: this could be to contribute to a market panic by explicitly repudiating lender-of-last-resort actions, or to contribute to inflation through fiscal and monetary expansion, or to contribute to deflation or ‘lowflation’ via fiscal and monetary resriction. To counteract market trends is to adopt the opposite policies in each of these circumstances. Case I, “joint irresponsbility,” is the outcome fear of which drove much of the enthusiasm for central bank independence in an inflationary environment, where it would represent both fiscal and monetary authorities adopting expansive policies. But it could equally reflect both the central bank and the government failing to act in the face of a market panic. Case II is the one Smaghi discusses, where the central bank compensates for inappropriate government policy. Case III would involve a central bank pushing in a direction opposite to government policy, where as case IV is coordinated policy to counteract market trends.

This diagram helps clarify when fiscal and when monetary authorities have the preponderance of bargaining power. When the central bank is constrained to fulfil an inflation mandate, the boxes shaded in gray are not available to it. Thus, the fiscal authorities unilaterally choose between options II and IV. Very often it has turned out that fiscal authorities have preferred to force central banks to go it alone instead of coordinating policy, even when the latter would have arguably generated better growth outcomes and more effective attainment of the goals expressed in the central bank’s mandate. The reason for this is that governments have other agendas for fiscal policy. Reagan wanted to “starve the beast,” Cameron to cut back the size of the state. Fiscal authorities arguably did not have to bear the full political costs of these macroeconomically inappropriate policies because central banks compensated for some of their negative economic effects. I think a good case could be made that the ability of elected governments to compel such compensatory action by central banks does serious damage to mechanisms of electoral accountability that are usually held to be at the heart of democracy’s advantages. 

On the other hand, when the central bank does have discretion, and the gray boxes are open to it, as in the lender-of-last-resort case, it can often impose its will on government policy. In particular, if the CB prefers case II to case III, and case III to case IV, then fiscal authorities fearful of their policies being undermined may have to choose to reinforce market trends as a condition of central bank action. This is what happened to some European governments when the ECB was willing to rescue government bond markets only on condition of austerity. 
The diagram above shows some empirical cases of each outcome, with ‘1970s’ standing in however approximately for joint monetary and fiscal irresponsibility. What all of this implies to me is that the idea that independent central banks bound by a policy mandate can serve as a useful check on elected governments depends, in fact, on an unrealistic conception of the circumstances in which central banks act (they will sometimes be called upon to act in areas beyond their mandate) and on the preferences of democratically elected governments (who may use mandates to force central banks to deal with the consequences of their inappropriate policies). The cases suggest that the Skcolidolg pattern has some real empirical relevance. 

What, then, is to be done? Some people argue for giving central banks more power over fiscal policy, especially in near-deflationary circumstances like at present. But it seems to me—I won’t try to defend the point in this already over-long post—that this runs the risk of exacerbating the problem of electoral accountability that has hindered electorates from understanding the impact of the macroeconomically inappropriate policies that right-wing governments seem so prone to run. Nearly two decades ago, Berman and McNamara argued that insofar as the case for the economic advantages of independent central banking was dubious, it provided no grounds for overriding the usual preference for favour of democratic governance in the case of central banking. When one looks at how central banking has interacted with democracy in practice, their case only gets stronger. It’s time to bring central banks back under the direct control of elected officials, so that they bear the responsibility for both good and bad choices about monetary policy. Ultimately, there’s no way to get the porridge right unless you make it yourself. 

Friday, 3 June 2016

Experiments in political science and the Cartwright critique

Over the course of the last couple of years, the political science discipline has twice hit the headlines for scandals linked to "field experiments." Maybe this isn't surprising: such experiments have become incredibly fashionable. Success in an academically fashionable endeavour can bring large rewards, and it's certainly plausible this has created incentives making fraud or poor judgement more likely.

To the extent that bad behaviour reflects incentives, one can always try to to police against it more vigorously. But changing incentives may be more effective. In this spirit, I'd like to encourage political scientists to stop being so damned excited by experiments and offering such big reputational rewards for them!

As a reason to calm down, consider some arguments (or great lecture version) from the brilliant philosopher of science Nancy Cartwright. Experiments (of the presently fashionable sort) rely on the logic of randomly assigning groups to "treatment" and "no treatment," so that any difference in outcome between the two groups can confidently be ascribed to the treatment. Yay, science!

Cartwright's core insight is that what such experiments can establish is only the role of a particular link in what might be a complicated, and highly context-dependent, causal chain. To build on an example she uses: Suppose you had a set of toilets, and assigned each of them randomly to have the lever attached to its side pressed or not. On completion of the experiment, you could confidently assert the relationship "lever pressing leads to water release." This formulation, though, would entirely obscure the point that these levers only release water because they are part of a mechanism to open a chamber supplied with water by pipes, etc.

Thus, if you went off to deploy your exciting new experimental result to solve California's drought by having everyone push the levers attached to the sides of their toasters, you'd be disappointed by the results. As Cartwright says (p.102), "Once stated this is an obvious and familiar point," but nonetheless one too often overlooked. This she effectively demonstrates with empirical examples of the disappointing performance of 'experimentally validated' policy interventions in new contexts.

So why is it that experimentalists are overlooking this obvious and highly consequential point?  [I'm not going to defend in detail the claim that they are, but will assert that the discussions about 'external validity' from experiment evangelists are not nearly searching enough.]  Let's use a little notation to make the argument more compact: the causes of an outcome O of an experiment are the experimental intervention I (such as lever pushing) + the rest of the mechanism M.  

So the question becomes, why the emphasis on I rather than M?

  • A lot of the methodological backdrop for political science experiments is drawn from experimental medical trials. In these, the common features of human organisms are regarded as similar enough that M will function in the same way. This assumption can be criticised even in a medical context, but for social scientists the issue is orders of magnitude more significant. 
  • Unlike pressing a lever, field experiments in political science are difficult to organise and often quite expensive. After all that effort to demonstrate the role of I, it's hard to remember that the M is important too.
  • I will often have been chosen precisely because it's the aspect of a broader mechanism that is easiest to manipulate. If the effects of M cannot be assessed via randomised controlled trials, then experiment absolutists will deny the possibility of making any meaningful claims about those effects. They haven't faced up to the fact that this means that they will never have any basis sanctioned by their own methodological precepts to assert that the results of one experiment have any generalisable implications whatsoever.

Whatever its origins, the mania for measuring the effects of interventions, and the corresponding neglect of the causal import of the context of these interventions, strikes me as very bad thing for many reasons, on which I hope to expand on another occasion.

PS: Cartwright's is not the only impressive critique of experimentalism on offer; I especially recommend Dawn Teele's edited volume. But so far, the critiques don't seem to have made much of a dent in the popularity of field experiments. Political science as a discipline seems to have an almost congenital need to affirm its 'scientific status'. But we should be suspicious of anything we need so much. How much did that ring really help Gollum?

Thursday, 10 December 2015

Puffing the magic Draghi

Mario Draghi had a rough time last week.  The extension of QE he announced disappointed markets, who were apparently expecting him to exceed expectations.  (Sounds oxymoronic to me, but I'm just a political scientist, not clever like a bond trader.) The upshot was a sharp rise in the value of the euro, which is a problem for a Eurozone demand model heavily reliant on exports.

Maybe Mario will be cheered up after Politico published a puff piece about him today. I wasn't; the article veered from the uninformative to actively misleading, reporting inter alia:  
Draghi ... [took] bold steps that enabled him to save the euro. Now that the danger of a disintegration of the eurozone has abated, the ECB president is embarking on an even tougher political task: to convince Europe’s governments that they must do their part of the heavy lifting to take the continent out of the slump. ... 
He is prodding EU governments to boost spending to put the European recovery back on a path to growth. ... 
For the moment, Draghi is happy to let Coeuré [ECB board member] and Praet [ECB chief economist] push the message that Germany in particular needs to splash out more on public infrastructure, to address what one ECB executive board member called an “absurd situation” where spending is so subdued that the fiscal deficit of the eurozone is much lower than the 3 percent allowed by the Stability and Growth Pact.
This a reiteration the myth that Draghi is an active supporter of a demand-stimulus approach to resolving Europe's growth crisis. However, all of the arguments I made against this myth more than a year ago remain valid. Above all, Draghi's shown not the slightest inclination to use his ample sources of political leverage to push for increased spending stimulus.  Nor has he repudiated his key role (see pp.34-38) in pushing for an austerity-led reaction to the Eurozone bond crisis, continuing to imply that no other choice was possible. As he recently put it, "don’t blame the fire damage on the fire brigade."

Perhaps, though, Draghi is beating the drums for demand stimulus behind the scenes? He is, after all, somewhat constrained as the public face of the ECB leadership.  Consider this exchange from the latest ECB press conference
Question: Last year in Jackson Hole, you advocated for a policy mix with monetary policy reforms, investment and fiscal policy, and today you have emphasised the role of fiscal policy. Do you miss more fiscal stimulus in countries with margin, like Germany, for example, and do you consider that the neutral fiscal stance that the European Commission is advocating for the eurozone as a whole is adequate now, in a sort of liquidity trap?
Draghi: We had a brief exchange on this issue, and our conclusion now is that, first of all, the first answer should be given by the Commission. The second point is that we'll continue reflecting on this, and we will have a view on what is the degree of appropriateness of the fiscal stance; whether we have a view about the aggregate fiscal stance; what is the degree of compliance with existing rules; whether the flexibility which has been exercised before all the terrible happenings of this year – so before the recent terrorist attacks, but also before the refugees events – whether that flexibility would be justified. So there are lots of factors in play altogether. How do we assess the fiscal stance today given the presence of the previous flexibility, the refugees, the need for security of the euro area? It's a very complicated question, so we are going to reflect on that.
One might read this as a sign that political conflict at the top of the ECB is limiting what Draghi can do by way of advocating fiscal sanity.  However:

  • Draghi has more than once found ways to move beyond the consensus of the bank's leadership, and there's no evidence he's trying to do so on this issue.
  • There is likewise no evidence that he personally views austerity as a crucial component of the growth catastrophe.  Asked at a November Europarliament meeting about what was needed to promote growth, Draghi had literally not a single word to say about government spending (see p.11).

Monday, 9 February 2015

Can Greece escape the ultimatum game? (And no, Draghi's not trying to help them do it)

At the start of a crucial week for Syriza's effort to negotiate a revision to the disastrous current arrangements between Greece and the Troika, I thought it would be helpful to try to describe the bargaining situation in a systematic way using game theory a very simple diagram (yes, it is game theory, but it's very straightforward).  Here it is:

The European Commission (EC) needs to decide whether or not they will propose a compromise or insist on the Troika's current terms.  Greece then needs to accept or reject the offer.  The rectangles at the far right show possible outcomes--if Greece rejects whatever the EC proposes, it leaves the Euro (Grexit).  Let's make some assumptions about how the parties rate the outcomes: Greece prefers a compromise to the Troika's terms, and both to Grexit.  The EC prefers the Troika's terms to compromise, and both to Grexit.

If this is an accurate depiction of the situation, the EC gets what it wants--it can face the Greece with the choice between taking the Troika's terms and Grexit, and Greece will choose the Troika.  It's an "ultimatum game;" Greece has to take whatever the EC offers, because otherwise it's faced with the catastrophe of Grexit.

So how can the Greek government change the game?

  1. Announce that it prefers Grexit to Troika terms. Then (bottom right in the diagram) Greece would be expected to choose reject, giving the Grexit outcome. Since the EC prefers compromise to Grexit, it would offer a compromise. So why doesn't Greece just do this?  
    • To announce this might set off an even worse banking panic than Greece is currently experiencing.
    • It only works if the EC reliably prefers compromise to Grexit.
    • It might not be believed
  2. Disable its capacity to accept Troika terms, or at least create uncertainty about whether it would be able to accept Troika terms (meaning that Troika intransigence would lead to Grexit)
    • This is one way to interpret Tsipras' "defiant" speech yesterday, in which he promised very publicly and very vigorously that Greece will not accept a continuation of the present Troika. (Political scientists just love talking about how "domestic audience costs" -- the costs of going back on a promise to a domestic constituency -- allow politicians to make threats on the international stage that would otherwise not be credible. Compare this discussion by Jacques Sapir.)
    • Again, this only works if the EC fears Grexit; Varoufakis is trying to make sure that they do
  3. Convince the EC leaders that compromise should be be preferred to Troika terms. So far this doesn't seem to be going very well.
  4. Find a way to create another possible outcome, with no compromise but also no Grexit
    • It's sometimes suggested that because Greece is presently running an obscenely large primary surplus (i.e., it's budget is heavily in the black before debt repayment is taken into account), it could just stop repayments, and abandon new borrowing.  However, since the Greek government can't print Euros, the sustainability of this path would depend on the cooperation of the ECB to keep the prospect of bank panics at bay.
So this week's negotiations will turn on whether the Greek government has managed credibly to cut off the possibility of accepting the Troika's terms and how much the rest of the Eurozone fears Grexit.  

PS: Was the ECB trying to help Greece by refusing to accept its bonds as collateral?

Last week, the ECB stopped accepting Greek government bonds as collateral for ECB loans. The immediate and obvious interpretation of this decision was that it continued the pattern (long version) of using the withholding of ECB emergency lending as a form of policy leverage. Paul Krugman pleaded unconvincingly that Draghi was too subtle for such a brutal display of strength, arguing that really this measure was meant to wake up Germany--a position the Greek government had little choice but to echo.  

One version of the claim that the ECB was not trying to intimidate Greece into accepting the Troika terms, proposed by Frances Coppola, rests on the idea was that weakening Greece strengthened its bargaining hand in a strategic context (as under 2, above).  But the argument doesn't work: A bargaining analysis offers no support for the idea that the ECB was trying to help Greece.  The ECB decision did nothing to make accepting the Troika conditions more difficult, or make Grexit relatively more attractive. Indeed, given that the ECB explicitly mentioned that it was the prospect of a failure in negotiations with the Troika over continued support for Greece that prompted the decision, it raised the benefits to Greece of a successful agreement. Moreover, to the extent that the decision signalled the likely attitude of the ECB toward supporting Greek banks in the absence of a successful agreement, it worked against option 4, as well. So to the extent that the ECB decision did reflect a bargaining logic (other things may have been at stake), it would make sense only as an effort to coerce Greece, not to help it. 

Tuesday, 16 December 2014

The Russian crisis and the Eurozone: some economic context

Pretty dramatic things are happening with the Russian rouble. Its dollar value is as of yesterday just about half of what it was on average in 2013.

What does this mean for the eurozone? Over the course of the first decade of this century, oil revenues and the real appreciation of the rouble made the Russian economy much larger in euro terms than it had been, and it correspondingly became a more important export market for eurozone countries. The share of Russia in the eurozone's exports tripled between 1999 and 2008; while it has declined slightly since, 4.7% of eurozone exports went to Russia in 2013. Given that even the eurozone's anaemic growth since the financial crisis is entirely attributable to export growth, this is not insignificant.

Source: Eurostat, OECD, EIA, own calculations. Brent prices and export/import figures nominal

In the chart, I've tried to give some indications of possible impacts of the rouble's fall by recalculating 2013 figures on Russian and eurozone GDP at yesterday's exchange rate, and giving a rough extrapolative estimate of how much exports to Russia might fall as a result of the declining purchasing power of Russian consumers in euro terms.

This estimate suggests a fall in sales to Russia of 0.5% of eurozone GDP, which would be highly significant, especially to an economy growing as slowly as the eurozone's is.  However, there are potential compensating factors (and potential further dangers):

Potential compensating factors

  • Russia's demand for imports may prove inelastic (consumers may not scale back purchases proportionately to the rouble's fall).
  • The eurozone will be spending less on importing oil, improving its trade balance. If consumers and businesses spend and invest the money no longer going to oil, this will promote growth. 
Potential further dangers
  • In liquidity trap conditions, consumers and businesses may not spend and invest the savings from cheaper energy prices. Then falling energy prices would simply contribute to the severe risk of deflation in the eurozone.
  • There could potentially be serious consequences to the international financial system of Russian companies being unable to pay back dollar-denominated debt (see here for a relatively sanguine discussion of their payment prospects). Financial fragility means that relatively small events can have a big impact.