Do we face a credit crunch?.

The weakness of credit growth in the United States and Europe has given rise to concerns that the financial crisis has led to a credit crunch which has deepened the recession in the real economy and poses a serious threat to the recovery that seems to have started in the most recent months. In this contribution we find that so far the development of credit aggregates and interest rates for loans does not provide strong evidence for a supply restraint that goes beyond hat could be expected given the deterioration of the quality of borrowers against the background of the exceptionally severe economic downturn. Still, the behaviour of interest rate spreads in the United States does indicate that the effectiveness of monetary policy is reduced for the time being as a result of distress in the financial sector, and we see some risks that inappropriate bank capitalization may restrain credit growth and threaten the current recovery, especially in Germany where core capital is low by international standards. Policy measures to avoid a credit crunch should focus on preventing undercapitalization of banks from becoming a serious limitation to credit growth.Kreditmarkt; Kreditrationierung; Zinsstruktur; Bankenpolitik; Eigenkapital; Deutschland;

For a stable monetary policy and tax competition in Euroland

Since the fall of last year, EMU countries have experienced a slowdown in economic activity triggered by a deceleration of exports. The expansion of internal demand has been more or less intact due to low interest rates and higher terms of trade. Consumer confidence has continued to rise and business confidence seems to have stabilized in early 1999. Economic activity in Euroland will gain momentum again in the course of 1999, mainly driven by domestic demand. The increase in real GDP will amount to 2 percent in 1999 and 2.7 percent in the year 2000. Monetary conditions are currently very favorable and will support the upswing. The three-month money market rate fell to 3.1 % following the concerted reduction of central banks' key interest rates in December 1998. Long-term interest rates are extremely low; corrected for inflation, the rate for Euroland is lower than the long-term average for Germany. In recent months, the growth rate of M3 has been somewhat higher than the reference value announced by the ECB (4.5 percent); narrow money has expanded twice as fast as M3. In addition, the euro has devalued considerably against the US dollar since the beginning of this year. Given the expectation that the slowdown in the economy is only of temporary nature, the ECB will not loosen its policy further but keep its key interest rate at the current low level for the rest of this year. The ECB decided to follow a medium-term strategy. Against this background, the current weakness in Euroland does not imply a need for action. Low inflation is also no reason to cut interest rates because consumer prices have been dampened by special factors, in particular the weakness of raw material prices, and not by a tight monetary policy. If interest rates were lowered in response to this transitory change, they would have to be raised again as soon as this effect fades away. Such a stop-and-go policy should be avoided. Likewise, the recent weakness of the euro against major currencies does not suggest that interest rates should be raised. For very good reasons, the ECB—as well as the American Federal Reserve Board—does not follow a target for exchange rates. According to the Stability and Growth Programs published by the governments, budget deficits in relation to GDP are projected to decline from 2.3 percent in 1998 to 0.9 percent in the year 2002 in Euroland. As the Stability and Growth Pact calls for a balanced budget or even a surplus over the medium term, fiscal policy is, in general, not yet on a course compatible with the intentions of the Maastricht Treaty. Only in smaller countries fiscal policy is making progress, while consolidation in larger member countries is not sufficient. It has often been argued that it is necessary to harmonize VAT rates and particularly capital income taxation in the EU in order to prevent a "race to the bottom", otherwise it would be impossible to supply an adequate level of public goods and to finance the welfare state. However, the development of capital income tax rates in the EU and in other industrialized countries does not provide evidence of a race to the bottom. But even if tax competition should become fiercer, there are still arguments in favor of competition: If tax rates are cut in a process of competition, government expenditures will have to decline with the result that inefficiencies in the public sector will be reduced. Given the high levels of government expenditures in most of the EU countries, there seems to be no risk that governments would be unable to fulfill their specific functions. In addition, tax competition might help to find better tax systems, and every country could learn from the experiences of other countries. In contrast, tax harmonization would probably lead to higher taxes in the EU. --

Upswing in Europe gains momentum, but unemployment remains high

The expansion of Western European production accelerated in the first half of 1997. Exports were the main engine, driven by a devaluation of European currencies and strong growth abroad. Domestic demand also picked up somewhat led by investment in machinery and equipment. Inflation remained at low levels. However, in most countries the bottom seems to have been reached. One major concern is the rise in import prices. The upswing will further gain momentum in the coming months and in 1998 as conditions shaping the cycle remain favorable. Real GDP in Western Europe will increase by 3 percent in 1998. Under the assumption that the decision concerning EMU due in spring 1998 is made in favor of a large monetary union, those countries with relatively high short-term interest rates will lower them quite substantially in next year. Against the background of high unemployment, countries with low interest rates will not raise key interest rates significantly. As a consequence, monetary policy in Western Europe on average will be further loosened. This will additionally stimulate economic activity but also raise risks of inflation. The major problem in Western Europe is unemployment, which remains stubbornly high or is even rising. As a contrast, unemployment in the United States has come down to the lowest level since decades. It is often stated that high unemployment in Europe is due to a restrictive monetary policy, led by a—supposedly—deflationary policy pursued by the Deutsche Bundesbank. This view, however, does not find any support when indicators of monetary policy are taken into account. Rather, they suggest that monetary policy has been expansionary in Europe for some time. In addition, the reduction of inflation since 1990 has been equally pronounced in Europe and the United States, which indicates that the monetary stance has not been significantly different. Furthermore, a striking fact in this regard is that the relatively steep fall of inflation in the United Kingdom was associated with a significant decline in unemployment. While total unemployment in Europe has followed an upward trend resulting in an approximate doubling of the rate, there have been notable exceptions within Europe. Among those economies that have experienced a decline in recent years are the United Kingdom, the Netherlands and Ireland; other countries seem to have joined the club. Overall, a variety of measures has contributed to the improvement of labor market performance in these countries. They include deregulations of product and labor markets that have led to wage moderation and more wage differentiation, and reforms of the tax and transfer systems that have resulted in improved incentives for both labor demand and labor supply. A central feature of individual countries' experience is that reforms tend to be more effective when they are comprehensive since there are important synergies between structural reforms in different fields. --