This is a very convenient moment to put up this post. Alan Greenspan has just admitted that he's human like the rest of us, and that he doesn't have a very good explanation for why long-term interest rates have been falling at a time when he and his Fed colleagues have been busy raising short-term rates. I think he's being a bit coy here, since I'm sure he has some idea. Among other things he will be well aware of the contents of a speech made recently by Ben Bernanke, a US economist who is considered high on the list of possible Greenspan successors.
What Bernanke said in the speech ( The Global Savings Glut ) was this:
"Iwill argue that over the past decade a combination of diverse forces has created a significant increase in the global supply of saving--a global saving glut--which helps to explain both the increase in the U.S. current account deficit and the relatively low level of long-term real interest rates in the world today. The prospect of dramatic increases in the ratio of retirees to workers in a number of major industrial economies is one important reason for the high level of global saving."
Later in the speech he spells this out in more detail:
"one well-understood source of the saving glut is the strong saving motive of rich countries with aging populations, which must make provision for an impending sharp increase in the number of retirees relative to the number of workers. With slowly growing or declining workforces, as well as high capital-labor ratios, many advanced economies outside the United States also face an apparent dearth of domestic investment opportunities. As a consequence of high desired saving and the low prospective returns to domestic investment, the mature industrial economies as a group seek to run current account surpluses and thus to lend abroad"
Now this speech has caused a fair degree of controversy due to the fact that it mainly has been seen as an apologetics for the high US current account deficit (which it - in part - is). But I would also argue that it has a deeper significance, in that this speech marks the arrival on the official agenda of what I would term the New Economic Paradigm: that is the idea that amongst the many important macro economic variables, one, population age structure, has a pride of place whose importance has not been sufficiently appreciated before.
Indeed, when I said Greenspan was being rather coy, I was retaining something up my sleeve, since I am aware that both Greenspan and Bernanke attended this conference at Jacksons Hole last summer where a prominent place was given to this paper from David Bloom, one of the evident 'brains' behind the New Economic Paradigm.
Undoubtedly the principal economic vital statistic for these theorists is the median age of any given population, and the most important information to have on hand when it comes to examining other *dependent* variables (like savings, investment, consumption, balance of payments, fiscal balance, labour force participation or productivity) is the age structure of the population.
Briefly put, what is argued is that each society has a prime saving age (for cultural reasons this may vary from one society to another): in the case of Italy (which we are considering here) this age group appears to be 35-64. The 65 plus age group progressively has more and more tendency to dis-save.
The other salient detail is the location of the 'boom generation': that generation which marks the inflection point in the demographic pyramid. Essentially the passage of this cohort into the dis-saving age group marks an important watershed in the evolution of any modern society.
Now for a specific case: Italy. The Management Consultants McKinsey and Co recently produced a report The Coming Demographic Deficit. You have to register on site to read the full report, but it is free and well worth it.
One of the chapters is dedicated to Italy. Below I reproduce the chapter summary which is pretty self-explanatory. The point is, whichever way you look at it the wealth producing capacity of Italy has peaked, and this is why that fiscal deficit is so important, the longer the deficit grows and accumulates, the greater the burden of paying it off. Perhaps before signing off here, and letting you get onto the McKinsey material, I could suggest why *I* think it is that there is so much liquidity, and such strong downward pressure on long term interest rates: simply put, for the reasons Bernanke suggests. Increased savings supply on the one hand, and diminished investment opportunities on the other, demand, side.
"Demographic pressure is expected to continue to drive down Italian household savings flows, further slowing the growth rate of household net financial wealth accumulation, with potentially significant implications for economic growth in Italy. MGI's analysis suggests that ? absent dramatic changes in population trends, savings behavior, or rates of financial asset appreciation ? Italian household savings will decline at 1.7 percent annually over the next two decades, causing a sharp slowdown in the growth of household net financial wealth, from the historical rate of 3.4 percent over the 1986-2003 period to 0.9 percent through 2024. By 2024, this slowing growth will cause net financial wealth to fall some 39 percent, or ?1.8 trillion, below what it would have been had the higher 1986-2003 growth rates persisted".
"The demographic transition has been underway in Italy for the past two decades. Since 1986 the median age in Italy has surged up 7 years, and over the next two decades it is expected to increase another 9 years, reaching 51 in 2024. Italy will have more than an estimated one million people over the age of 90 by 2024."
"With its aging population and the number of working-age households continuing to grow more slowly than elderly households, the demographic structure of Italy will become increasingly less able to support wealth accumulation, a good proxy for economic well-being. Slower growth in wealth is likely to mean slower growth in future living standards. For the economy, there will be less household savings to support a fast-growing retiree population, and it will become more difficult to support domestic investment and sustain strong economic growth. The fact that the rest of the developed world is experiencing or is about to encounter similar aging trends means that Italy cannot rely on inflows of foreign savings to make up for its domestic shortfall."
"To navigate smoothly through this transition and to offset this strong demographic pressure, Italian households and their government will need to take steps to reverse the decrease in saving and to improve the returns that households obtain on their portfolios. Mitigating the demographic forces already at work in Italy will be challenging and will require sustained, coordinated efforts by the public and private sector".
Italy At A Glance - January 2008
Welcome to the Italian Economy Watch Blog. Below you will find the normal chronological blog posts. But first we would like to present some charts which provide background data which we hope will help the first time reader better assess and get to grips with the argument being presented on the blog. In what follows you can find charts for Italian male life expectancy, median age, quarterly GDP growth, inflation, household demand, retail sales, and import and exports growth. Basically this data provides a summary of the argument which we are presenting on this blog, which is that in order to understand Italy's long term and ongoing economic malaise you need to understand something about Italian demography, and it's macroeconomic consequences. Please click on thumbnails for better viewing.
With such weak internal consumption growth Italy badly needs to run a trade surplus to obtain the economic growth necessary to make public finances sustainable. In this Italy is similar to Germany and Japan, and different from domestic consumer driven economies like the UK, France and Ireland. Long term fertility and life expectancy really do matter, since they condition labour force growth
and consumption patterns, and with these productivity and the growth of internal credit and consumer demand. Above left you can find Italy's ferility rate, and above right the evolution of the 25 to 49 age group, which has just passed it historic peak. On either side here you can see charts for recent quarterly GDPand long run annual GDP.
Arguably these are all the data points you need to understand my lengthy post on The Euro Area and Italy's De-Facto Dependence On Exports, as well as why it is that the danger Italy may once more fall into recession presents us with the difficulty of what the credit ratings agencies will say about the resulting impact on the government debt situation.
2008 Forecasts: The OECD in December revised their 2007 Italian forecast down to 1.8%, and the 2008 one down to 1.3%. Confindustria also revised their forecast down in December, arguing that growth would slow to 1 percent in 2008 from an 1.8 percent this year, citing factors like the rising cost of food and oil and the rise of the euro against the dollar. Such numbers are clearly not encouraging, but arguably downside risk for 2008 is greater even than either the OECD or the Confindustria forecasts reflect Morgan Stanley's Vladimir Pillona is somewhat more sanguine. While presenting the MS central forceast for Italian economic growth to slow to 1.0%Y in 2008, from 1.8%Y in 2007, he goes on to note that "even annual GDP growth of 0.5%Y next year has a significant possibility of occurring, as shown by our model’s forecast error bands".
I personally will be very surprised if we still see calendar year 2008 anything like as high as 1.8%, but more to the point even 1.3% may be rather on the high side if we get a significant deterioration in the external environment, especially in Eastern Europe on which Italy is fairly dependent, and where the Italian banking sector has significant exposure. So that puts me much nearer to Pillona's "basement bargain" number of 0.5% than to any of the others. One of the reasons for my pessimism relates to my assessment of Italy's current trend growth rate, and to the level of fiscal and monetary tightening which may be operating on the economy even as it slows. During 2007 the Italian govenment has been running a fiscal deficit of comfortably below the 3% of GDP required by the EU commission. But since this fortunate situation was in part acheieved by the use of one off measures, and in part by the strong tax inflow from the above trend growth, the government will need to maintain a comparatively tight fiscal stance to keep things on course, and any attempt to further loosen may run into real problems with the EU commission and the credit rating agencies. And as I keep arguing, it is very hard to see an accomodative monetary posture from the ECB in the near future. The IMF in their October World Economic Outlook came in with a similar figure of 1.3% for 2008, the Economist Intelligence Unit is forecasting 1.7% in 2007 and 1.4 in 2008, and the latter 2008 figure was also endorsed by the EU commission in its November forecast.
As I indicate, my own view is well to the downside of all this. The only apparent bright spot on the horizon is employment, but I am dubious that in the context of Italy's ageing workforce this will work through as some are hoping, as I expain at some considerable length in this post here. My opinion is that Italy will enter recession at some point during 2008, and that we may well have 2 consecutive quarters of negative growth. The continuing high euro will maintain pressure on Italian exports, and high oil and food prices will maintain pressure on the inflation front, at least in the firts half of 2008. At the same time, and despite rumours that Romano Prodi's government is compemplating a large tax cutting package, I anticipate that the fiscal environment will remain tight. Italy's large (106% GDP) accumulated debt, and the vigilance from the gentlmen at Standard and Poor's and the other credit rating agencies more or less guarantee that.
As most of the forecasts suggest, we have been seeing growth which is somewhat above trend during the upswing in the last couple of years, so it would not be surprising if we now saw some below trend growth. Trend growth (over a 5 year average) in Italy may even have fallen into the 0.5 to 1% range, so if I have to put a number I would say 0.7% with a definite "downside risk" tag attached. The nearest forecast to this that I have seen is the 1% one from the Morgan Stanley GEF team. The implications of such sustained low growth are, I think, important, since if Italy cannot find the way to raise trend growth up towards the 2% mark there is simply no way the government debt can be stabilised and sustained. And with each passing year we have one year less to crunch time.
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