Economic Conditions in the Euro Zone

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Economic Conditions in the Euro Zone

• Presentation prepared by
• Saima Ahmed
• Vito Giurazza
• Gonzalo Gomez-Arrue Azpiazu
• Andreas Habersetzer
• Cem Padir

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Agenda

• Euro zone description
• European Central Bank vs. Federal Reserve
• Economic conditions in Euro zone
• The recent policy stance of the ECB
• Prospects of interest rates in the Euro zone

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Euro Zone Members and Criteria

• Refers to the European Union member states that
  have adopted the Euro Currency Union
• Official Members (15) - Austria, Belgium, Cyprus,
  Finland, France, Germany, Greece, Ireland, Italy,
  Luxembourg, Malta, Netherlands, Portugal,
  Slovenia, Spain
• As of 2007 Euro zone is the largest economy in
  the world. It began in 1998 when 11 member
  countries met the convergence criteria and the
  Euro was launched
• In order to become part of the EU each country
  must also qualify for the Economic and Monetary
  Union. This is accomplished via 3 stages of
  economic policy/the convergence criteria (details
  in attachment) culminating with the adoption of
  the Euro
• The Convergence Criteria cover price
  developments, fiscal developments, exchange rate
  developments and long-term interest rate
  developments
• Having met all the criteria the EU member nation
  has ten years to adopt the Euro as its currency

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Monetary Policy Coordination
Euro Zone Monetary Policy coordination and
implementation
Monetary Policy Implementation

• The Eurosystem employs an operational framework
  via the ECB to implement the single monetary
  policy
• Monopoly supplier of the monetary base, which
  includes currency in circulation, reserves held
  by counterparties, and recourse by credit
  institutions to the Eurosystem deposit facility.
• Signaling monetary policy stance
• Ensuring proper functioning of the money market
• The Guiding Principles of the operational
  framework are
• Operational Efficiency
• Equal treatment and Harmonization
• Decentralized Implementation
• Simplicity, transparency, continuity, safety and
  cost efficiency

• The European Central Bank (ECB) is the core of
  the Eurosystem and the European System of Central
  Banks (ESCB). It is responsible for implementing
  monetary policy in the region.
• Within the ECB, there are three bodies
• The Governing Council is the main decision making
  body. Consists of 6 members of the Executive
  Board and Governors of the ESCB of the 15 member
  countries.
• The Executive Board consists of the President,
  Vice President and four other members.
• The General Council consisting of the President,
  Vice President and Governors of the Central Banks
  of all 27 EU member states.

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Agenda

• Euro zone description
• European Central Bank vs. Federal Reserve
• Economic conditions in Euro zone
• The recent policy stance of the ECB
• Prospects of interest rates in the Euro zone

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ECB vs. Fed mission and political mandate

• Due to ist dual / multiple mandate, the Federal
  Reserve Bank has the ability to give stimulus to
  growth by reducing interest rates
• However, a central bank cannot systematically
  implement an expansionary monetary policy that
  stimulates economic activity without producting
  more inflation over time

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ECB vs. Fed task and tools
Note NCBS refers to national central banks of
the EUROSYSTEM
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Agenda

• Euro zone description
• European Central Bank vs. Federal Reserve
• Economic conditions in Euro zone
• The recent policy stance of the ECB
• Prospects of interest rates in the Euro zone

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Economic conditions in EU

• The inflation rate is 3.5 for Euro Zone
  (changing composition but includes all EU 27).
• The inflation is increasing due to distress in
  world markets, some are getting hit hard (the
  increase is more significant in the Fifth
  Enlargement countries)

Inflation

• Unemployment Rate of EU-13 (the main indicator
  because of the employment structure of EU) is 7
  (03/2008)
• Unemployment is decreasing still, but its still
  high and labor laws are the main cause of this
  rest of the world still works more than Europeans

Unemployment

• The GDP Growth is 2.21 annually. With the
  turmoil in the worlds financial markets, and the
  credit crunch, the output growth is decreasing
• While still not in a recession, nobody can say
  its not going there
• We saw increasing inflation, and decreasing
  output. (Stagflation?)

GDP growth
() Fifth Enlargement Countries include Czech
Republic, Estonia, Hungary, Latvia, Lithuania,
Malta, Poland, Slovakia, Slovenia, Bulgaria and
Romania
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Agenda

• Euro zone description
• European Central Bank vs. Federal Reserve
• Economic conditions in Euro zone
• The recent policy stance of the ECB
• Prospects of interest rates in the Euro zone

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Policy of the ECB links

• The primary objective of the ECBs monetary
  policy is to maintain price stability. The ECB
  aims at inflation rates of below, but close to,
  2 over the medium term.
• Since nominal interest rates cannot be negative,
  a small positive inflation is easier to control
  than deflation
• Inflation is measured using the Harmonised Index
  of Consumer Prices (HICP) which tends to slightly
  overestimation
• A single index is defined for the whole Euro Zone
  even though there are small local differences
  keeping a target of 2 avoids running into
  deflation locally
• Monetary policy cannot impact the short term
  variability in prices
• Attempts to accommodate to short term shocks can
  have negative repercussions in prices in the
  medium term (particularly when the root of the
  local variation is a supply shock)?

Mission statement
Why lt2 inflation?
Why medium term?
Source ECB website
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Policy of the ecb the taylor rule or the
tailored rule? (1/2)

• Due to its definition (focus on controlling
  inflation alone) we would expect the ECB to
  follow the Taylor rule when setting interest
  rates
• The simplest and most common form of a Taylor
  rule is

• There is some freedom as to how the parameters
  should be chosen (leading, lagging...)?
• The rule can be modified to account for many
  other factors (exchange rate, interest rate of
  other economies, money growth...)?
• According to some studies, the ECB seems not to
  be following a Taylor rule focused on inflation
  when establishing interest rates between 1999 and
  2002
• Actually, the countries themselves seemed to be
  much more strict about it right before the
  adoption of the Euro!
• Due to the fact that policy makers have to make
  decision based on the incomplete information
  available at the time, ex-post analysis may be
  misleading, though

Source 2003, Katrin Ullrich A Comparison
Between the FED and the ECB Taylor Rules -
http//ideas.repec.org/p/zbw/zewdip/962.html
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Policy of the ecb the Taylor rule or the
tailored rule? (2/2)

• ...or it could be that the ECB is using forward
  looking rules based on surveys
• ...or it could be there is not enough data
• ...or it could be corrective actions are taken in
  small steps
• ...or it could be the inflation was not really
  that far from the target
• ...or it could be the ECB has been confronted
  with specially volatile times
• Different authors disagree on how the ECB
  implements its policy

Source 2003, Katrin Ullrich A Comparison
Between the FED and the ECB Taylor Rules -
http//ideas.repec.org/p/zbw/zewdip/962.html
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Policy of the ECB Recent facts and the analysts
voice

• The interest rate has remained unchanged since
  June 2007 at 4.00
• ECB's intention was to raise it to 4.50 during
  the second half of 2007 to control inflation,
  which has since jumped to 3.5
• According to its mission statement, the ECB
  should raise the interest rates even further at
  some point soon and has expressed its intention
  to do so 'if necessary'
• The staggering GDP growth, the strength of the
  Euro and the strategies being followed by other
  central banks suggest otherwise

The recent past

• It is very likely that the ECB will use the
  slightest opportunity to lower the interest rates
  in order to foster competitiveness and growth of
  the Euro area
• Analysts expect inflation to go down in the
  Eurozone in the next months, along with a decline
  in the price of oil
• Any decrease in inflation will allow the ECB to
  cut the interest rates, which are expected to
  come down by about as much as 0.50 by September

The future (for the analysts)
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Agenda

• Euro zone description
• European Central Bank vs. Federal Reserve
• Economic conditions in Euro zone
• The recent policy stance of the ECB
• Prospects of interest rates in the Euro zone

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Prospects for interest rates in the Euro Zone
RESEARCH ESTIMATES
Overall market expectations (Euro Zone Yield
Curve)

• Lehman Brothers expects two rate cuts from the
  current level of 4.00 to 3.25 in twelve months
  time
• JPMorgan Chase also expects the ECB to cut rates
  twice (June and September)
• Royal bank of Scotland forecasts a rate cut for
  May or June
• Due to the high level of inflation, research
  analysts expect the ECB to cut rates later than
  prviously prognosed

• Markets see only a slight reduction - if any - of
  short term interest rates over the next six
  months

Sources Lehman Brothers Euro Area Weekly
Economic Outlook www.ft.com www.iht.com
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Attachments
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Three Stage Creation of the EMU

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Inflation (03/2008)

• The inflation rate is 3.5 for Euro Zone
  (changing composition but includes all EU 27).

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Unemployment (EU 13)

• Unemployment Rate of EU-13 is 7 (03/2008)
• EU-13 is the main indicator because of the
  employment structure of EU.

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GDP Growth (02/2008)

• The GDP Growth is 2.21 annually.

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Inflation of Fifth Enlargement Countries