The two faces of uncertainty
GUIDO TABELLINI, BOCCONI INTESA SANPAOLO CHAIR IN POLITICAL ECONOMICS, ARGUES IN THIS INTERVIEW THAT THERE IS A RISK OF RECESSION IN BOTH THE US AND THE EU, AND THAT MONETARY POLICY WILL HAVE TO BE RESTRICTIVE IN AMERICA AND LESS EXPANSIONARY IN EUROPE TO CURTAIL RISING INFLATION. AS FOR THE WAR, IT COULD ACCELERATE EUROPEAN INTEGRATIONby Federico Fubini
Translated by Alex Foti
Guido Tabellini is convinced that the current phase, characterized by a dramatic war in Europe that is occurring while recovery from the impact of the pandemic was still incomplete, requires a double reading. Currently holder of the Intesa Sanpaolo Chair in Political Economics and Bocconi Rector between 2008 and 2012, Prof Tabellini thinks that there is a high immediate risk of recession in advanced economies. At the same time, he sees the political conditions, at least in public opinion, for further steps in European integration.
Professor, how will advanced countries respond to the inflationary wave of the last year?
Certainly, the risk of recession is very high both in the United States and in the European Union. In the United States, if there is one, the recession will be caused by the tightening of monetary policy, which is lagging behind price dynamics for essentially two reasons. At first, many thought inflation was only due to supply-side shocks caused by problems along the global supply chain and war-related hikes in energy prices. They did not realize there was a very large component of excess demand in the United States due to over-expansionary fiscal policy implemented by President Joe Biden.
How has the US administration contributed to the rise in inflation?
It launched expansionary fiscal policies that proved pro-cyclical, because the economy was already recovering after the 2020 recession. And for months the Federal Reserve exaggerated to attribute the rise in inflation only to supply-side shock. But there is also a second reason for the lag in monetary policy and this is more understandable: with official rates at zero or below zero, everyone was aware of the asymmetric risk of being wrong about the timing of tightening. Central banks, precisely because they were so close to the 'zero lower bound', knew that they would have very little room for maneuver in implementing policies to support the economy if a premature squeeze had created unexpected setbacks. On the contrary, they knew they had more room to react to excessive overheating: a delay in acting could be corrected more easily.
Isn't that a bit like the situation we are in today?
We all now understand that this inflation will not stop without restrictive monetary policy. Even core inflation, without more volatile factors such as energy or food, is too high. As a result, real wages have dropped a lot, but in the United States there are historically very low unemployment rates and labor shortages, so a wage-price spiral has ensued. To change course, monetary policy has no alternative to raising unemployment. Because inflation slows down if the economy slows down. It is difficult to gauge the right measure of monetary tightening. The economy is like a huge ocean liner, responding slowly and imperfectly to economic policy maneuvers. It will have to get very close to recession and probably enter it, for the Fed to be able to reduce inflation.
Is the same true for the euro area?
The euro area is in a similar but slightly different situation. Excess demand is certainly less pronounced, fiscal policy has been less expansionary and unemployment is on average higher. But Europe is more exposed than the United States to rising energy prices and the contractionary effects of war. To thse recessive tendencies, soon will be added monetary policy that is likely to become less expansive and perhaps even restrictive. It is likely that Italy and perhaps also Germany will go into recession in the second quarter of this year. Monetary policy has yet to begin to become restrictive, it will do so in the months ahead and the considerations made for the United States are partly valid in Europe as well. The monetary policy of the European Central Bank has less of need to become strongly restrictive, especially if the price shocks on the supply side are not passed on to wages. In that case, the inflationary effect would only be temporary. But in Germany there is already evidence that wage contracts with unions are being affected.
A large part of the euro area economy is already in recession. The ECB does not risk repeating the mistakes of 2008 and 2011, when it was frightened by above-target inflation and aggravated the ongoing recession by raising rates?
In 2008 and 2011, the ECB's mistake was not understanding that monetary policy would aggravate the ongoing financial crisis and, in any case, we were in a time of a squeeze in demand. Now there is a supply-side shock and international demand has been very strong since the exit from the pandemic. Inflation today is not a local phenomenon, but a global one. And the euro has depreciated significantly against the dollar, thus potentially contributing to higher inflation. Given that there is the risk of expectations about inflation changing and wages starting going after prices, it is right to take away some of that expansionary push. Maybe it should have been done first. It is simply a matter of normalizing monetary policy.
Christian Lindner, the German finance minister, worries that the financial fragility of the most indebted European governments, Italy especially, is forcing the ECB to practice a more accommodating monetary policy than necessary. Is it a well-founded fear?
I think Lindner is right: there is no doubt that one of the reasons why the ECB is shy about reversing the monetary policy cycle is the fear of Italian public debt instability.
Don’t you find, however, that the European Union on the Ukrainian crisis has not shown the kind of cohesion and capacity for integration conversely seen during the pandemic? For example, joint purchasing of vaccines was decided in 2020, while today major EU countries compete against each other to import liquefied natural gas from around the world
What you say about energy policy is true, but in foreign and defense policy, many have been surprised by Europe's response and show of cohesion. The unity was greater than what could have been expected ex ante and Putin certainly expected. This is important, also because in the case of foreign and defense policy the EU has no specific competence and this makes it more difficult to give a compact European response. After all, the covid shock was uniform, very similar in all countries, while the current energy shock is more heterogeneous: Italy and Germany are more dependent from Russia on gas than many other countries. Also, other geographic aspects now matter more. For example, proximity to Africa in the past was considered a disadvantage for Italy, but now it makes it easier for the country to diversify energy supplies.
Do you believe that this geopolitical crisis, like the health crisis, will push the European Union towards greater integration?
The push towards political and institutional integration, all over the world, has always come from external common threats. The war is an opportunity to make progress in the European Union and it is possible that in the coming months we will make institutional reforms.
Is public opinion in European countries ready?
On this issue, I conducted studies with Alberto Alesina and Francesco Trebbi a few years ago. Our conclusion was that perhaps we are exaggerating in perceiving Europe as a group of countries that have differing opinions and diverging interests. Within-country differences of opinion turn out to be of an order of magnitude higher than cross-country differences. Italy is full of internal heterogeneity, as are France and Germany. If we look at the opinions of citizens in European countries regarding political choices or cultural attitudes, there is enormous heterogeneity within countries, while national averages in opinion are very similar".
What do you mean?
Let's take two averagely representative citizens who belong to different countries and two citizens of the same country selected with the same criterion. Well, the fact that two citizens are from different countries increases the probability of disagreement of a factor between 5% and 10%. But disagreement between citizens is large within countries, where there are however adequate institutions to reach political compromises. The point, therefore, is not so much heterogeneity between EU countries, but the existence of institutions recognized as legitimate by all and suitable for striking a balance between political differences.
