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ANGELA MERKEL

Central bank bombshell sparks debt debate

German Chancellor Angela Merkel may have sought to score political points by slamming central banks last week, but she also echoed fears over growing public debt and waning bank independence.

Central bank bombshell sparks debt debate
Photo:DPA

Merkel shocked financial markets when she said in Berlin: “We need to get back to an independent central bank policy and a policy of common sense.”

Her rare criticism singled out the US Federal Reserve in particular, as she expressed scepticism over “the extent of the Fed’s powers,” which include the authority to buy $300 billion dollars (€210 billion) worth of government and private debt.

Merkel’s remarks came days before a rate decision by the European Central Bank (ECB). The ECB, she said, had “bowed to international pressure with its purchase of covered bonds,” a non-conventional measure to boost credit markets.

The comments also preceded a European parliament poll this weekend and a general election in Germany in September, prompting the Financial Times to call her comments “political point-scoring.”

But the German chancellor’s warning that monetary policy was out of control was welcomed by the Wall Street Journal, which said her “broadside” against the Fed, the Bank of England, and the ECB was “timely.”

“Central banks should halt the printing presses before the real damage is done,” the US daily warned.

Merkel and others in Germany feel that pushing up deficits to fight the economic crisis will fuel inflation and sow the seeds of the next crisis. By buying government debt, some economists say the Fed and Bank of England have surrendered independence that Germans cite as a key factor in a healthy economy.

“There is no real autonomy or independence of the Fed any longer in my view,” UniCredit economist Andreas Rees told AFP. “This is dangerous.”

Meanwhile, “Germans are traumatized by the hyper-inflation in the 1920s,” which helped bring the Nazi party to power, Barclays Capital economist Torsten Polleit noted. “Americans are traumatized by the Great Depression, by deflation,” he added.

The main danger now is deflation, a sustained period of falling prices that chokes economic activity and drives up unemployment, but less than a year ago eurozone inflation hit a record 4.0 percent amid soaring energy prices.

Unsurprisingly, Merkel also got the attention of central bank chiefs, with Fed chairman Ben Bernanke telling a US congressional panel the next day: “I respectfully disagree with her views.”

Bernanke nonetheless warned US lawmakers against failing to rein in a huge budget deficit, saying: “We cannot allow ourselves to be in a position where the debt continues to rise.”

That has put strong pressure on the yield of US Treasury bills, which the Fed wants to bring down with its purchases because they set a benchmark for other interest rates, such as those on mortgages or corporate bonds.

ECB president Jean-Claude Trichet said Thursday he had spoken with Merkel and was pleased she “was fully backing our independence and appreciated what we were doing.”

Trichet added that he and Merkel agreed that governments must be set to reverse the effects of economic stimulus plans quickly once the eurozone’s recession was clearly receding. “Exit strategies are of the utmost importance,” the ECB chief stressed.

Financial markets have signalled concern over soaring government debt, as seen in a sharp hike in the yield on US Treasuries and rising momentum of inflation expectations, which nonetheless remain at reasonable levels for now.

“This is a warning signal that the assessment of international investors in terms of inflation expectations could change very quickly,” Rees said. That could drive up the cost of government and private borrowing before officials managed to get to grips with the recession.

“The psychological shift can happen more rapidly” than policymakers expect, added Timo Klein at IHS Global Insight.

Polleit said: “If the programme like the one the Fed has announced to keep buying and monetize government debt (continues), the problem will really start to kick in.”

He felt that “over the next four to five years, there is just one direction in terms of public debt. It will go up” because “the majority of the public and politicians see government handouts as basically necessary.”

Against such a background, Merkel’s bombshell could benefit the ECB, several analysts noted.

“In a way, Merkel is actually strengthening the position of the European Central Bank,” Klein said, by backing those who feel the bank was “coaxed into additional steps by the example of the Fed and the Bank of England and others.”

Key among them is German central bank governor Axel Weber, an influential ECB governing council member in regular contact with the German chancellor.

Klein stressed that “Merkel is genuinely concerned about having a too loose monetary policy and not being able to unwind these measures in time, and she is not afraid to say so.”

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ECONOMY

How is Denmark’s economy handling inflation and rate rises?

Denmark's economy is now expected to avoid a recession in the coming years, with fewer people losing their jobs than expected, despite high levels of inflation and rising interest rates, The Danish Economic Council has said in a new report.

How is Denmark's economy handling inflation and rate rises?

The council, led by four university economics professors commonly referred to as “the wise men” or vismænd in Denmark, gave a much rosier picture of Denmark’s economy in its spring report, published on Tuesday, than it did in its autumn report last year. 

“We, like many others, are surprised by how employment continues to rise despite inflation and higher interest rates,” the chair or ‘chief wise man’,  Carl-Johan Dalgaard, said in a press release.

“A significant drop in energy prices and a very positive development in exports mean that things have gone better than feared, and as it looks now, the slowdown will therefore be more subdued than we estimated in the autumn.”

In the English summary of its report, the council noted that in the autumn, market expectations were that energy prices would remain at a high level, with “a real concern for energy supply shortages in the winter of 2022/23”.

That the slowdown has been more subdued, it continued was largely due to a significant drop in energy prices compared to the levels seen in late summer 2022, and compared to the market expectations for 2023.  

The council now expects Denmark’s GDP growth to slow to 1 percent in 2023 rather than for the economy to shrink by 0.2 percent, as it predicted in the autumn. 

In 2024, it expects the growth rate to remain the same as in 2003, with another year of 1 percent GDP growth. In its autumn report it expected weaker growth of 0.6 percent in 2024.

What is the outlook for employment? 

In the autumn, the expert group estimated that employment in Denmark would decrease by 100,000 people towards the end of the 2023, with employment in 2024  about 1 percent below the estimated structural level. 

Now, instead, it expects employment will fall by just 50,000 people by 2025.

What does the expert group’s outlook mean for interest rates and government spending? 

Denmark’s finance minister Nikolai Wammen came in for some gentle criticism, with the experts judging that “the 2023 Finance Act, which was adopted in May, should have been tighter”.  The current government’s fiscal policy, it concludes “has not contributed to countering domestic inflationary pressures”. 

The experts expect inflation to stay above 2 percent in 2023 and 2024 and not to fall below 2 percent until 2025. 

If the government decides to follow the council’s advice, the budget in 2024 will have to be at least as tight, if not tighter than that of 2023. 

“Fiscal policy in 2024 should not contribute to increasing demand pressure, rather the opposite,” they write. 

The council also questioned the evidence justifying abolishing the Great Prayer Day holiday, which Denmark’s government has claimed will permanently increase the labour supply by 8,500 full time workers. 

“The council assumes that the abolition of Great Prayer Day will have a short-term positive effect on the labour supply, while there is no evidence of a long-term effect.” 

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