Sunday, November 24, 2013

Can Structural reforms help Europe!



Structural reforms
The introduction of the single currency has allowed the accumulation of deep macro economic imbalances within the Euro area. Some member countries have generated current account surpluses, while others dug large current account deficits. These imbalances are explained in the loss of competitiveness "peripheral" countries: their real exchange rate has appreciated by 6-15 % compared to few others between 2001 and 2009. These losses of competitiveness explain themselves in part by strong price increases observed in the markets of non-tradable goods, particularly in the property sector. When imbalances are settled violently in 2009, the periphery has shifted into a severe recession and public debt is soaring mechanically. During an economic crisis, each member country of the Euro area can not vary its exchange rate to stimulate activity.

 Therefore, the peripheral countries have sought to simulate a devaluation of the exchange rate. For this, they have implemented structural reforms aimed at increasing competition in the labor markets and products. These include reducing the one hand, the monopoly power of firms and, on the other hand, the bargaining power of workers. In this way, the reforms allow favorable price drops and in purchasing power, prevent excessive wage increases, stimulate entrepreneurship, job creation, etc. Adopting structural reforms, peripheral in Euro area countries hope to regain competitiveness and improve their current balance. In addition, as the reforms are supposed to get agents to expect higher growth in the future, so encourage them to spend today, they should stimulate domestic demand. Structural reforms should they be provided in place when economies are in recession? When aggregate demand is insufficient or governments increase their spending directly to restore the level of aggregate demand , or the central bank eases monetary policy to stimulate private spending. If, in such a context, governments are forced to adopt austerity plans; that is in view of stabilizing the public debt and reassure markets about the sustainability of public debt, then the drop demand accelerates.

However, if the shock is particularly violent, a central bank may not be able to sufficiently lower its key rate to bring the economy to full employment and prevent the onset of deflation. Anticipating a further decline in prices and wages, private agents have an incentive to postpone spending in time, which leads firms to lower new prices and wages. Deflation is also reflected by an increase in real interest rates, which increases the burden of debt. Households and businesses are then no incentive to borrow, but rather to deleverage, which depresses the purchase of new durable goods.

In this case, households are encouraged to reduce their expenses if they anticipate a deterioration of employment protection in times of mass unemployment. Structural reforms cannot be implemented in a recession if governments and central banks are able to offset the impact on aggregate demand. Otherwise, they feed the contraction. Far from building trust and encourage investment, reforms may maintain pessimism and savings behavior. Therefore, they also degrade the potential growth by maintaining long-term unemployment and disincentive for companies to invest.