12/03/2012

UK: IS THE SPECTRE OF INFLATION BACK?

The cornerstone of the Bank of England's (BoE) monetary policy framework is its inflation-control system, the goal of which is to keep the rise in the consumer prices index at 2%. However, since 2005 the inflation rate has been almost uninterruptedly higher.

Over the next few quarters, inflation should decline as a number of short-term factors drop out of the figures, such as the VAT rise and surges in import and energy prices. What is more, in the current weak labour market there seems little chance of runaway wage inflation. Finally, the output gap will not be closing for several quarters yet and this will help depress any inflationary pressures in the short term.

That said, inflationary risks cannot be ruled out in the longer term. In March 2009, the BoE launched its quantitative easing programme (QE) to boost liquidity on the credit market and give economic growth a shot in the arm. When the time comes to wind down this programme, which currently totals GBP 325bn, the BoE will find itself facing three possible risks, all of which may tend to push inflation above the 2% target. These are a loss of the BoE's credibility, a misreading of the output gap and governmental pressure to continue QE.

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20/01/2012

Eurozone periphery adjustment: is Latvia an example?

Despite an unprecedented economic downturn in 2008-2009, Latvia has avoided both a currency devaluation and a financial crisis. Instead, it pursued a strategy of “internal devaluation”, i.e. price and wage deflation, in order to unwind its huge imbalances.

The adjustment strategy relied on a combination of international support, fiscal consolidation and unwinding of external imbalances. Surprisingly, sizeable fiscal adjustments were undertaken without largescale social resistance or political crisis.

Latvia is referred to as an example for the eurozone countries under IMF assistance, which have also opted for internal devaluation in order to increase their competitiveness. However, Latvia’s adjustment succeeded thanks to a series of country-specific factors, making probably of it a special case not easily replicable.

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13/12/2011

China: internationalization without convertibility of the renminbi

Over the last few years, the international use of the Renminbi (RMB) has been growing steadily through the following: (i) the conclusion of several RMB bilateral currency swap agreements between the People’s Bank of China and other foreign central banks; (ii) the expansion of RMB cross-border trade settlement; and (iii) the increasing role of Hong Kong as an offshore RMB financial hub.

While the use of the RMB as a unit of account and a means of payment has significantly expanded, the lack of its convertibility limits its function as a store of value, preventing its full internationalization.

However, some preconditions would need to be fulfilled before achieving convertibility of the RMB: a stronger domestic banking system, deeper financial markets and greater flexibility in the exchange rate regime.

Full internationalization of the RMB is thus likely to be a long way off.

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09/06/2011

United States: State and local governments are dampening the recovery

In the United States, States, municipalities and other local governments were hit extremely hard by the recession. Federal government assistance, which until recently had enabled them to contain their deficits, is coming to an end, which means that a rapid and significant adjustment is needed.

The risk of default of State or local governments cannot be completely ruled out, but this remains restricted to a small number of local governments.

However, the required improvements to their balance sheets constitute a risk to the country’s still fragile recovery, as local governments represent a substantial portion of the economy (15% of total employment and 12% of GDP for their consumption and investment expenditures).

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10/05/2011

Is Africa about to take off?

Economic growth in Africa has increased markedly since the start of this century. Both “exogenous” (such as rising commodity prices and increased trade and capital flows with emerging markets) and “endogenous” factors (such as improvement in macro-economic policy and political stabilisation) have explained this acceleration.

African growth is expected to continue this path. The continent's growth potential will be supported by commodities (energy, minerals and soft commodities) and demographics (i.e. increase in the labour force and emergence of a middle class).

However, strong growth doesn’t automatically translate into true social development. Many political challenges remain, including consolidating democratic progress. Lastly, if the “overall” growth potential of the continent is undeniable, individual/regional performances may prove uneven.

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31/03/2011

The dollar: The Americans' currency, their problem?

The United States are regularly suspected of varying the dollar’s exchange rate to their advantage and to the detriment of other economies, none more so than the euro zone. The Fed’s quantitative easing policy (QE2) recently revived this debate.

If this suspicion were founded, we should witness a counter-cyclical behaviour of the dollar value, with the greenback appreciating during expansion phases in the US economy and depreciating during recessions. However, analysis of previous cycles does not show evidence of a significant relationship between the US economy and the dollar fluctuations.

In contrast to another broadly accepted idea...

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