MNI INTERVIEW: Euro Recession Possible By Mid-Year: Schularick

By Luke Heighton

     BERLIN(MNI) - Europe's economy could be in recession by the middle of this

year if coronavirus and Brexit combine with ongoing geopolitical uncertainty and

concerns over the outlook for the Chinese economy, economist Moritz Schularick

told MNI in an interview.

     "I'm not positive for 2020 and 2021. The reasonable prediction would be

that going forward returns on assets will be low," Schularick, a professor at

University of Bonn and expected to become a senior advisor to the New York Fed

on macrofinancial issues, said during the conversation in Berlin on February 24.

"There is also quite a long line of shocks and potential negative risks lined up

- the coronavirus, Brexit negotiations, uncertainties regarding the political

situation both within the U.S., and between the U.S. and other countries."

     Should the economic effects of the virus prove less long-lasting and severe

than feared, the loss of production could be made up. However, Schularick

cautioned: "There are questions about the trajectory of the Chinese economy even

if a pandemic is contained, and the uncertainty shock of that. I wouldn't be

surprised if we find ourselves in a recession in the middle of this year; it's

not at all to be excluded."

     He was sceptical as to whether the European Central Bank could do much to

address a supply-side shock to the euro zone, though there would, he said, be a

temptation to prevent any downturn spilling into the broader economy.

     "Clearly if this is the trigger for much more severe global growth slowdown

or supply-chain disruption there will attempts to stabilise the outlook by

saying they stand ready to support the demand side of the economy," Schularick

said, while expressing concern at the lack of firepower available to central

banks to fight the next recession.

     --QE

     "More asset purchases within the fixed income space are probably on the

horizon," he said, "but the marginal benefits are simply not as big as they used

to be. You can still intervene in equity markets. The problem with all these

financial transmission mechanisms is that it's not clear how effective they are

- setting interest rates even more negative could eventually have the opposite

effect to ones intended."

     "Intervening in equity markets and making rich people even richer against

the current backdrop of populism and concerns, real or imagined, around wealth

and income inequality, puts central banks on a slippery slope," he added.

     "If the only policies that are left are those that have major

distributional implications, then you might say that, from a democratic point of

view, these are not choices that independent central bankers should make."

     Interest rates are likely to stay close to their current level for another

five years, but Schularick said that inflation could reach 2% within a decade

with more active fiscal policy, including in Germany, if it overcomes its

long-time commitment to a so-called "schwarze null", or balanced budget.

     "The schwarze null fetish is increasingly questioned. It will probably

change with the next government, and that could be very soon. The next

government will be a coalition, and will be one that is more fiscally active,"

Schularick said.

     Sentiment among German companies is "not good" he warned, with structural

problems and the changing nature of the global economy posing challenges to

Europe's largest economy.

     "Germany has done very well over the last 20 years exporting cars and

machinery to the rest of the world. The next 20 years are not going to be that.

In an environment of growing economic nationalism, the idea of running large

trade surpluses and investing those surpluses at mediocre yields in the rest of

the world, of exporting your way out of [trouble] is no longer valid."

     The next decade will instead, Schularick predicted, be one of domestic

investment: "We transfer 7-8% of GDP abroad every year, when we could use that

very well at home and in Europe. The good news for Europe is that there is

plenty of inefficiency, so there is quite some growth that can be unleashed."

--MNI London Bureau; +44 203 865 3829; email: jason.webb@marketnews.com

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