MNI INTERVIEW: Gov't Spending Limits ECB Easing Space- Wieland
MNI (LONDON) - High levels of government debt and spending have pushed up the neutral rate of interest, leaving the European Central Bank little room to ease monetary policy, former German Council of Economic Experts member Volker Wieland told MNI.
European Union public debt-to-GDP ratios are likely to grow even more in coming years, even in traditionally fiscally-conservative Germany, said Wieland, now Chair of Monetary Economics at the Institute for Monetary and Financial Stability in Frankfurt.
“Germany is a bit different because of the debt brake that was strengthened by the recent Constitutional Court ruling. Even so, government spending and transfers will remain close to a 50% share of GDP, compared with the 43-44% seen from 2013 to 2019. So both the upward trend in debt, the upward trend in government activity as a share of GDP would push up the equilibrium rate,” he said. (See MNI SOURCES: ECB Neutral Rate Debate Heats Up As Growth Weak)
Speaking in an interview as the ECB is widely expected to cut its deposit rate by 25 basis points to 3.5% later this month, Wieland said market expectations that it could eventually be reduced by as far as to 2% would imply a “rather low” real equilibrium rate of zero. Overnight index swaps currently imply about 141 basis points of cuts to the deposit rate by next July.
“The Fed’s median estimate is a neutral federal-funds rate of 2.8%. If for the ECB it’s around 2.7-2.8%, there really isn’t so much space to ease - in which case, why not see how things pan out and perhaps do more next year?” said Wieland, who is also a member of the Scientific Advisory Council of the German Ministry of Finance.
Market expectations of inflation returning to the ECB’s 2% medium-term target may be less firmly anchored than they appear, he added. (See MNI INTERVIEW: Vital ECB Returns Inflation To 2% By 2025 - Wunsch)
FRAGILE EXPECTATIONS
“We saw post-Covid that expectations shifted upwards in the tails, so it might be the case that things have become more fragile. Certainly in Germany, the Bundesbank’s household survey showed very high expectations during the inflation surge, and they remain at or above 3% for the next 12 months and beyond," he said. “This is higher than in the ECB’s euro area consumer survey. It may be that market participants, firms and households will take the risk of inflation being substantially higher to heart, even if that is not the case right now.”
Regarding German inflation, Wieland cautioned against reading too much into the most recent data which suggested prices rose just 1.9% in August, with the more comprehensive GDP deflator measure likely to suggest a figure “certainly well above” 2%.
“Interestingly, during this disinflation the ECB has been looking more closely at the deflator in the context of the debate around profits and wages. It’s also there in the June Economic Bulletin where they discuss the readiness of companies to accept smaller profits as a result of higher unit labour costs. I think that’s a positive development,” he said.
GERMAN OUTLOOK
Wieland found little reason to think a turnaround in Germany’s stagnant growth outlook is imminent, with poor business and consumer confidence set to continue.
“Maybe consumers are thinking that we're staying in a higher interest rate regime, which is an incentive to save. Another perspective could be that the higher rates come from government indebtedness, and not from an indication of higher potential growth. Thus households might need to save more for retirement. That would certainly fit well into the German mood at the moment.”
The failure of Germany’s “Traffic-Light” coalition government to reach agreement on a Federal Budget for 2025 is “ pretty pathetic, in the sense that it casts the current coalition in a very weak form,” Wieland said, adding that it was indicative both of an unwillingness to consolidate public spending and an inability to reach a deal over what are, in relative terms, "very small" amounts of money.
“All the components of government spending are up and are going to keep growing. Social spending has continued to grow in real terms while the economy has not. Having said that, there are some positive elements in the government’s new growth initiative, in particular, where regulation and bureaucracy is being reduced.”