Inflation Target and Monetary Policy Normalization

Inflation Target and Monetary Policy Normalization

In an International Monetary Fund (IMF) staff position note in 2010, Olivier Blanchard and his colleagues argue that it could be useful to consider, during normal times, raising the inflation target of central banks in advanced countries. Specifically, they point to raising the inflation target from 2 percent to 4 percent to be able to avoid the zero interest rate bound when an advanced country central bank has to cut rates during periods of deflationary recessions. “Should policymakers,” they ask, “therefore aim for a higher target inflation rate in normal times, in order to increase the room for monetary policy to react to such shocks?”

John Williams, the president of the Federal Reserve Bank of San Francisco, also recently raised, for the purpose of Fed policy normalization debate, the same point that Blanchard and his IMF colleagues made in their paper. It is doubtful, however, if raising the inflation target is a viable proposition during these still abnormal times when the United States continues to be near the zero bound and the eurozone and Japan are experimenting with negative interest rates primarily to boost inflation to their 2 percent target.

The debate about raising the inflation target from 2 to 4 percent by advanced economies requires analysis during two time periods – normal times and deflationary times – as Blanchard and Williams respectively brought up. The behavior of the central bank would be similar to how it would behave when targeting 2 percent inflation. During normal times, a 4 percent inflation target requires the central bank to hold off on raising interest rates until long term inflation expectations rise beyond 4 percent. In periods of deflationary recessions, monetary policy normalization cannot take place, likewise, until long term inflation expectations rise beyond 4 percent.

A central bank, during both normal and deflationary time periods, may preemptively begin its monetary tightening policy once it sees, in data, long run inflation expectations rising potentially beyond the 4 percent target. Further, during both time periods, the central bank will have longer wait times to tighten monetary policy because inflation has to rise in forecast beyond 4 percent. In other words, the economy would be around the “natural” interest rate during normal times, and during deflationary times it would be at lower interest rates for prolonged periods until the whites of the eyes of inflation rising beyond 4 percent can be seen in the data.

In both normal and deflationary periods, contrary to expectations by policymakers that a higher inflation target would increase monetary policy room to react to negative shocks to the economy and help policymakers avoid the zero interest bound, it is not clear what the “natural” interest rate is and if it would be high enough to provide policymakers the room they desire to cut before the zero interest rate bound can be reached.

A higher inflation target could have nominal effects by simply raising prices and wages or have real effects by raising the potential growth rate of an economy. It does not, however, say much about an economy’s “natural” interest rate to expect that rate to be comfortably high enough to avoid the zero bound on the way down when necessary. If anything, the “natural” rate would be low enabling the central bank to tolerate inflation at a higher target such as 4%.

During deflationary times, such as nearly the past decade in advanced economies, a very large and sustained fiscal expansion accompanied by very gradual monetary contraction from the zero bound is a sound approach to normalizing monetary policy, not raising the inflation target.

A Framework of Macroeconomic Policy In a Regime of Monetary Policy Normalization

Observers of central banks are finally beginning to see wisdom in macroeconomic policy coordination. Central bank independence, when understood in context, is really dynamic interdependence between the various macroeconomic policy instruments to stabilize an economy, “economic stabilization” meaning low and stable inflation and stable output at potential and at full employment. Thus far, since the crisis of 2007-2008, the combination of monetary expansion and fiscal contraction (austerity) has only worked, undesirably, to keep a downward pressure on output. With the governments tightening their belts, even extremely low (and in some cases negative) interest rates from central banks have not been sufficient to raise output and inflation.

That fiscal expansion should support the extraordinary monetary easing in Europe and Japan is legitimate but in the United States, which has already entered into a period of monetary policy normalization because output is close to potential and inflation is near Fed target, continued monetary easing supported by fiscal expansion may not be desirable, but fiscal expansion per se is necessary to renew the country as was the case after the Great Depression.

The tax structure, including corporate taxation, in the United States needs a revamp to both simplify and ease the tax burden on both individuals and corporations, and, to prepare for the rest of the 21st century, tax payer funds need to be invested in large infrastructure projects for national renewal such as roadways, high speed rail and air traffic control systems. Also, tax incentives are necessary in the energy and transportation sectors to eliminate dependence on fossil fuels. Further, tax support for information and communications technologies (ICTs) needs to be boosted for the country to continue to lead the world in the sector. All of this must be done while normalizing the monetary policy regime.

A recommended macroeconomic policy framework for achieving monetary policy normalization and fiscal expansion is for the Federal Reserve to continue to very gradually raise the federal funds rate while directly financing government spending and tax expenditures on fiscal programs by printing money so that government borrowing and the debt-to-GDP ratio do not rise. This combination of monetary contraction and very large fiscal expansion would be unorthodox policy – a form of “helicopter money” transfer to the government – as Milton Friedman had once stated and as Ben Bernanke had reiterated during his tenure as Fed Chairman – together with monetary policy normalization.

islm

Such a macroeconomic policy framework of monetary contraction, and fiscal expansion funded directly by the central bank, as can be seen above from simple IS-LM analysis, will push the real equilibrium interest rate up and at least maintain stable output if not increase it, and will correct the distortions caused by the financial crisis while not unduly burdening the government’s finances despite the very large size of the much needed fiscal expansion.

Does Central Bank Credibility Depend On Causing Economic Growth?

credibility

Inflation targeting has become accepted monetary policy wisdom around the world. Under inflation targeting, interest rate policy of the central bank, both when an economy is growing and when it is slowing down, acts to modulate inflation around a set target to give investors and consumers the confidence that inflation in the future will neither be too high nor too low so that they can plan their economic activities. Low and stable inflation is said to provide predictability in planning for investors who then invest in capital (plants and machinery) for production and create jobs which leads to economic growth because of higher private investment across an economy and consumption.

Evidence, however, is split on whether stable inflation causes economic growth but it is clear that expanding money supply causes growth and contracting it slows down an economy. Then, during periods as now when extraordinary monetary accommodation is not being effective and efficient in causing growth, it raises the question as to whether central bank credibility is being hurt in spite of inflation being low.

Inflation can rise beyond its target typically in two ways: (1) an economy overheats and growth surpasses the economy’s potential growth rate leading to increase in prices and wages because firms have to add new production capacity and pay workers more because the labor market is already at full employment and new workers are difficult to add because they are so few or (2) money supply can lead to higher prices and wages without affecting any of the real variables such as investment. In both of these instances the central bank intervenes by raising interest rates to lower money supply in order to keep a lid on inflation – in the first case by slowing growth and in the second case by simply making less money available to chase the same goods and services.

The current economic condition of the world is such that the link between money supply, investment, employment, prices and wages has become tenuous with the monetary transmission mechanism failing in both of the cases – (1) despite monetary largesse, economies are producing below their potential and in some instances the potential growth rate itself has fallen and (2) ever more money is not raising prices and wages. Money is being hoarded by banks and corporations without it gainfully circulating within the economies.

Monetary policy credibility as a macroeconomic policy instrument is at stake because money is neither causing growth nor is it raising prices and wages (the nominal variables). This, thus, leads one to ask whether continued money supply expansion, as is currently the case, is necessary to set the monetary transmission right or if policymakers should instead focus on fixing the monetary transmission mechanism for existing money supply to be effective and efficient in causing growth. It is clear that continuing to put more money into an economy when the monetary transmission mechanism is broken is not going to lead to the desired results. The mechanism needs repair by policy edicts or statutes to make better utilization of the existing money supply.

Who, when formulating the inflation target as a monetary policy mechanism, would have foreseen that it is not inflation but growth which would test the credibility of central banks. But such is the circumstance now and policy and law have to respond accordingly.

Neither Say Nor Keynes. Or Is It Both?

225px-Jean-baptiste_SayKeynes_1933At a time when the debt-to-GDP ratios of countries are high and monetary policies have been extraordinarily expanding money supply through unconventional means to little in response from the economies in terms of growth, the Keynesian critique of classical economics comes under scrutiny: why are policy efforts to create demand falling by the wayside? After all, Keynes postulated that demand creates its own supply in direct contrast to the law of classical economics propounded by Jean-Baptiste Say that supply creates its own demand. Neither are prices and wages rising – as would be the classical economics case if money were neutral or superneutral – nor is real investment going up as would be the Keynesian case if money is expected to be invested in capital equipment to cause employment and growth.

It has been nearly a decade since the crisis of 2007-2008. For economists this is the “very long run” in which time frame there should be no trade off between inflation and employment and the economy should be at full employment. Developed economies, instead, are caught in a money supply glut. The extraordinary money supply is holding the economies above water, preventing them from sinking into a recession. No amount of effort to lower the long run interest rate is being sufficient to spark real investment, with banks holding very high excess reserves at their central banks and corporations hoarding cash.

The fear that there could be little demand if corporations increase investment is holding it back and the uncertainty that higher demand through consumption as in the past – which was debt-laden in the absence of commensurate increase in wages – cannot be sustained because of a recovering job market, not significant wage gains, changing structure of the labor market (example: the emergence of the gig economy), and low savings rate among consumers is failing stabilization policies. This vicious cycle of low investment and low demand has to be interrupted by government policy if economies are to recover well.

What then should be the innovation in government policy to enable a healthy economic recovery which does not need monetary and fiscal support as it does now? First, the excess reserves of banks with their central banks should be used to raise real investment rather than raising prices of goods, services and financial assets. To do so, the various real investment options for firms to invest in must be explored and incentivized by the government through fiscal policy such as corporate tax breaks and, by law, the government should prevent uses of excess reserves in areas other than real investment. Second, to get around the spectre of increasing the indebtedness of countries, the central banks should directly fund government expenditures such as toward infrastructure which will, beginning in the medium term, attract their own private investment.

Jean-Baptiste Say is correct. Supply creates its own demand as has been seen throughout history. Innovation creates products, thereby, markets for products and, hence, demand. Keynes is also correct: demand creates supply. Supply and demand can feed on each other in both positive and negative reinforcement cycles. The role of government policy is to promote the positive reinforcement cycle through measured, targeted and timely intervention in the economy.

How Are the US Markets?

The uncertain behavior of the US financial markets since the beginning of 2016 in response to an economic slowdown in the rest of the world has led to some investors asking whether the equity and bond markets in the US have become frothy. Closer observation reveals that in 2016 the US markets have been digesting the bad news about the macroeconomic environment of the rest of the world even though its impact on the US economy is minimal given the US economic structure which is largely predicated on the performance of the domestic economy. The focus of the US financial markets, after reacting to bad news from abroad, has always returned home to adjusting to the American macroeconomic fundamentals and the health of US corporations as reflected by their earnings.

It is being said that there is an “earnings recession” in the US for the past three quarters. Steadily declining profits of US corporations quarter after quarter have raised the question of whether a recession could follow. Alleviating such concerns, American economic expansion since 2009 is continuing but below the potential growth rate for the US economy. The US consumer is confident because of the robust labor market, and because the investment opportunities elsewhere in the world are not as attractive, domestic production capacity is being utilized and should be utilized to the fullest in the immediate future, further lowering unemployment which is already at “full” employment, before corporations can engage in new investments.

Still, some market analysts contend that the average price-to-earnings (P/E) ratio of S&P 500 corporations is very high, overvaluing companies, and that either earnings have to rise or the stock prices have to decline, reverting the P/E to its historical mean, to better reflect the business environment notwithstanding that P/E may, in fact, not be a mean reverting time series. Indeed, economic conditions in the rest of the world have pushed US market indices into correction territory when they declined more than 10% in the beginning of 2016, but the indices recovered after that due to the resiliency of US economic performance. It is important to note here that P/E ratios can be elevated because of low inflation and inflation has been low and below Fed target for sometime.

It can be said, looking at US market indices since 2009, that stock prices have built into them GDP fluctuations and corporate earnings and have entered a phase of diminishing returns: the rise of all the three market indices – DJIA, S&P 500 and NASDAQ – has plateaued as can be seen from the charts below:

Dow Jones

Dow Jones

 

NASDAQ

NASDAQ

 

S&P 500

S&P 500

The question then becomes “what next for the markets?” There are three possibilities: (1) GDP growth rate and earnings continue at the current level; or (2) GDP and earnings rise leading to further increase in stock prices; or (3) GDP and earnings decline because of a slowing economy or an external negative shock. This implies that markets will plateau, rise, or fall based on GDP and corporate earnings.

The Federal Reserve Bank of Atlanta’s latest GDPNow forecast of US GDP for the third quarter (Q3) is 3.7%, significantly better than the economic performance in the first two quarters of 2016. Assuming this trend would continue and that Q3 corporate earnings likewise would rise, the US financial markets can look forward to continuing to rise.

Income Inequality, Population Aging and Economic Stagnation

In a 1938 paper, economist Alvin Hansen had argued that the post-Great Depression economy of the United States could be in secular stagnation – an economic condition where growth is low or negligible because of low population growth rate and reduced immigration. He proved to be wrong because of Keynesian policies to recover from the Depression-era economy and the post-war baby boom years which significantly raised the population growth. But Hansen could be correct now: developed economies could be experiencing secular stagnation due to a different set of conditions.

Economic growth in advanced countries after the Great Recession of 2007-2008 has been anemic. In the presence of austerity measures and, therefore, in the absence of any significant fiscal expansion (fiscal expansion being a Keynesian policy prescription), economic recovery has been slow and prolonged despite quantitative easing and zero and negative interest rate policies of central banks.

Advanced countries are experiencing two phenomena at the same time: income inequality is rising and the working population is aging. Both of these trends do not bode well for consumption which makes up close to 70% of the gross domestic products (GDPs) of these countries. As income inequality rises, lower and middle income portions of the population whose marginal propensity to consume (MPC) is higher than that of the upper income group will not have sufficient disposable income to spend thus putting a downward pressure on consumption. Also, once in retirement, bulk of the aging population will have less income, their capacity to take on new debt will be significantly less, and will not be able to consume as they had during their earning years.

Despite the expected tendency to consume less because of lower and uncertain incomes in the face of rising income inequality, majority of the households in lower to middle income quintiles have thus far spent more than they could afford by raising their debt-to-income ratios until the housing bubble burst. The ensuing financial crisis has crimped debt-driven spending, further dampening GDP growth in advanced countries for the foreseeable future.

Then, what to do about secular stagnation? Keynesian policy prescriptions actually work. First, income redistribution is necessary. A tax policy which taxes the wealthy to provide quality public education and healthcare for the rest of the society is needed. More importantly, wages have to be made less unequal by a tax policy which ensures equitable wage distribution in the corporate sector through more socially responsible corporate governance. Also, expansionary fiscal policy that raises government investment in public works and infrastructure to renew it and to create jobs should work just as it did in response to the Great Depression though the short-term boost any economy receives from war should be avoided (it has been argued that primarily the US entry into World War II had put the United States back on a growth path more than public works).

The world is experiencing a paradigm shift in how it uses energy and water, two critical resources for economic development and growth. All governments around the world would be wise to incur tax expenditures to incentivize the ongoing transformation so that fiscal policy is in support of and in coherence with the expansionary monetary policy that is underway globally to make monetary easing more effective by showing avenues where the private sector can gainfully invest and be an important part of the long term structural change the global economy is undergoing.

That fiscal policy has not adequately or not at all supported monetary expansion in the post-financial crisis period since 2009 is a fact. This must change if the developed world is to extricate itself from grip of both income inequality and the consequent secular stagnation because the financial cycle which is ahead of the economic cycle in the United States faces the danger of collapsing at some point, despite the extraordinary monetary policy, if economic growth does not support the high private corporate valuations.

Are We Facing a Permanent Rise in Income Disparity?

In the 1950s and 1960s, economist Simon Kuznets had advanced the hypothesis that as an economy develops, income inequality first rises and then falls. An inverted U-curve, also known as the Kuznets Curve, graphing income inequality on the Y-axis and income-per-capita on the X-axis depicts the Kuznets’ hypothesis. Kuznets was describing the effects of structural changes in the economy caused by industrialization and the attendant shift from agriculture to industry and migration of labor from rural to urban areas. More broadly, the Kuznets Curve is helpful in understanding the distributional effects of technological change: as technological change happens income inequality initially rises because of the need for new skills and labor displacement by new technologies – also known as technological unemployment – and it later falls as labor adjusts to new technologies by acquiring new skills and wages rise. Productivity increases and economic growth rises over the period of the Kuznets Curve.

Kuznets Curve

Kuznets Curve

Income disparity has steadily increased since 1969 because of innovations in computing and financial services. The 40-year period from 1969 to around 2009 has been dubbed the Third Industrial Revolution. The First Industrial Revolution of 1784 was brought about by technological advances in steam, water and mechanization of production. The Second Industrial Revolution of 1870 consisted of division of labor, electricity and mass production. In all three industrial revolutions short-term disruptions of the labor market by new technologies gave rise to technological unemployment and later, typically in a generation’s time (roughly 18 years), as labor acquired new skills to suit the new structure of the economy, wages rose and income inequality narrowed.

We are once again in a period of profound technological change, but this time there is pervasive anxiety that it could be different from past such changes. The Fourth Industrial Revolution, as the zeitgeist is called, is producing cyber-physical systems blurring the line between the physical, digital and biological spheres. With the focus in the information technology sector shifting to artificial intelligence, futurists are speculating about the coming singularity where machine intelligence surpasses human intelligence by the year 2050, becoming self-aware with the capacity to replicate and improve itself autonomously.

It has been estimated that computerization by artificial intelligence and robotics could displace 47% of total US employment. However, this technological unemployment could be different from technological unemployment during past industrial revolutions because intelligent machines could permanently displace human labor, and the total number of jobs created – because new technologies could require much higher skill levels – could be far fewer in number than the total employment needs of a country. Productivity could rise substantially, economic growth could also rise, but at a high level of income inequality in an economy where every job from analytics and financial trading to accounting and routine secretarial work could be automated by the year 2050 in developed economies. There could be a wide gulf between high skill/high pay and low skill/low pay jobs in an economy, exacerbating income disparity.

The contribution of this article to the literature on economic growth and income inequality is that the exponential nature of technological advancement during this Fourth Industrial Revolution could lead to permanently high income inequality in contrast to the Kuznets Curve hypothesis. It is, therefore, little surprise that ideas such as Universal Basic Income (UBI) are being entertained by developed economies so that poverty does not increase substantially due to permanent displacement caused by technological change.

Is the Growth Story of the United States Essentially Over?

Well known Financial Times’ economics commentator Martin Wolf concludes his opinion piece on global growth “An end to facile optimism about the future” by saying that “[t]he view that steady and rapid rises in the standard of living must endure is a pious hope. The tendency to believe that some “structural reforms” will fix this is, similarly, an act of faith. It is essential for policy to promote invention and innovation, so far as it can. But we must not assume an easy return to the long-lost era of dynamism. Meanwhile, the maldistribution of the gains from what growth we have is a growing challenge. These are harsh times.” Wolf, in his article, was opining on Robert Gordon’s book “The Rise and Fall of American Growth” which documents and analyzes US economic development and growth from 1870 to 1970 and the subsequent slow down: Gordon says that invention and innovation in the US have not had the same impact on both standard of living and quality of life since 1970 as they had between 1870 and 1970 and that he does not expect them to in the future.

A quick look at the US economy shows that most of American growth comes from within its borders. It has been a long while since America’s net exports in its gross domestic product (GDP) have been positive. Since about 1981 the United States has always imported more than it exported and net exports have been a drag on US GDP. International trade became a foreign policy tool for the US by entering into trade agreements which were largely pacts to import foreign goods and services in exchange for advancing US interests such as democracy and market economics. The opening of China by Nixon and China’s rise since then and the North American Free Trade Agreement (NAFTA) are salient examples of US trade and foreign policies. Two generations of such trade and foreign policies since 1981 have taken their toll on the American middle class and resistance to them, which began with the defeat of George H.W. Bush in 1992 by Bill Clinton, is now peaking in the society leading to the rise of the likes of Bernie Sanders and Donald Trump. The American growth story may not, however, be over.

Invention and innovation in the United States may not be of the same nature as they have been between 1870 and 1970, but equitable implementation of the idea that large developing countries such as China and India can grow with the help of free trade is sufficient to contribute to the growth of both America and the rest of the world. The opening of other economies to existing American technology and business models for their domestic development is a win-win for America and the rest of the world: billions of new consumers, as development creates new middle classes elsewhere, will be added to the global economy benefiting American multinational corporations and the domestic populations in the rest of the world. The key to such robust growth in America and the rest of the world in a manner that is sustainable requires the evolution of institutions of democracy and open market economics. We are increasingly seeing the interdependence of capital and product markets worldwide. As this happens one would only see benefits of it accruing to America and the rest.

The only path, besides government policies encouraging invention and innovation, to continued rise in the standards of living in America, and the developed countries in general, is to promote development in the rest of the world and to ensure that the gains from this are equitably distributed.

These are not harsh times but times of profound and hopeful change in the world where countless people are aspiring to better their lives by not only accessing the same inventions and innovations which have benefited America between 1870 and 1970 and thereafter but also themselves eager to invent and innovate.

The Global Economy and Market Dynamics

Volatility has characterized the global financial markets thus far in 2016. Slow growth in two successive quarters in the United States beginning in the last quarter of 2015 and continuing into the first quarter of 2016 and weak economies in most of the rest of the world has sapped market confidence in the global economy. The US Federal Reserve’s decision to hold back interest rate increases because of slow US growth and market volatility has not helped the markets. Brexit has shocked the global financial markets toward the end of the second quarter of 2016 reigniting worries about slow global growth. India remains the only bright spot on the global economic landscape.

US economic outlook generally tends to influence the rest of the global economy given the size of the American economy and the large role the US dollar plays in global trade. The most watched indicator of US economic health is the Fed’s outlook of the US economy and the expected reaction function of the central bank. Beginning with 2016 the Fed’s outlook has been one of uncertainty for the US economy which has made the markets volatile.

The Fed putting its expected gradual interest rate hikes on hold signaling an uncertain economic outlook both for the US and for the US in the context of the rest of the world typically depresses the US dollar relative to other currencies, oil and equities. Bond prices rise because of flight to safety and bond yields go down. Gold, typically an inflation hedge, rises as a safe haven commodity asset to hold during uncertain economic times despite inflation being low.

On a relative basis, in the current global economic context, despite slow and uncertain growth in the US, the shock of Brexit to the UK and the rest of the EU is strengthening the US dollar because of weakness in the British pound and the euro. Together with the US dollar, the Japanese yen is also acting as a safe haven currency, strengthening relative to the US dollar and other currencies despite Japan’s economic troubles. Investors are seeing the US dollar and the Japanese yen as being relatively stable compared to the uncertainty in the UK and the EU. China has reacted to the uncertainty in the UK and the EU by weakening the trading band for the Chinese yuan.

Potential risks to the global economy are currently the US and China. Recession in the US, prospect of which is low at the moment, or further slowdown or a crisis in China in an environment of already extraordinary global monetary stimulus can further lower global bond yields as bond prices rise due to flight to safety and also cause an equity sell off. Gold, in exclusion of the US dollar and the Japanese yen, could further rise and oil could fall off steeply. Such an environment might need a strong fiscal stimulus worldwide for the monetary stimulus to be effective – only further delaying the global economic recovery.

One can only hope that adverse economic conditions do not materialize in the US and in China.

Brexit

Britain has chosen to exit from the European Union (EU). Europe and the rest of the world had expected the British people to at least choose narrowly to remain in the EU. The choice to leave the EU was an unexpected result of the referendum and hence a shock for the global financial markets which have been left to come to terms with the consequences of Brexit.

The immediate reaction of the equity and currency markets has been to fall steeply in expectation of the worst case scenarios of Brexit consequences to play out: recession in the United Kingdom (UK); political turmoil in Britain as demands for the exit of Scotland and Northern Ireland from the UK resurface; the spread of political and economic contagion in EU and the Economic and Monetary Union (EMU) as other EU and EMU member countries seek to exit; and finally, the fragile economies of the EU and the global economy being pushed into recession. But really, what can be the consequences of Brexit?

UK is a small economy. It had a GDP of about 3 trillion USD in 2015. It ranks second behind Germany in Europe and mostly trades with the EU and the United States. Brexit only increases the trade friction between the UK and the EU until new trade agreements both with the EU and bilaterally with specific European countries are entered into. The exit negotiations of the UK from the EU after the invocation of Article 50 of the Lisbon Treaty are expected to take about 2 years and therefore there would be no immediate effect on trade and hence no immediate repercussions for either the UK or the EU economies.

The global economy is far too big for the temporary fall in the British pound and the euro to affect it too negatively. If anything, British and EMU goods would be cheaper for other countries thus boosting UK and EMU exports. Brexit, having come at a time of global economic slowdown, by hampering UK and EU recoveries could slow global economic recovery but will not adversely affect it.

The future of Britain could be similar to that of Norway and Switzerland. Frankfurt could become the second major financial center after London in Europe and that would be good for the continent as a whole.

Though the possibility of secession of Scotland and Northern Ireland from the UK is real, it is premature to expect the unravelling of the EU and EMU because of Brexit. To go on with the European project of ever closer economic and political union, the EU needs to focus on economic recovery to address unwarranted nationalist sentiments and requires responsible political leadership at a time of change.

The financial markets will subside in a few weeks after the Brexit shock.