The Week That Was in Europe Klaus Adam & Dirk Schumacher

Countries across Europe and the United States have witnessed a significant surge in government debt and interest rates in the aftermath of the Covid-19 pandemic. Join us as we engage in a conversation with Vítor Gaspar, Director of the IMF's Fiscal Affairs Department, about possible stability risks confronting government finances and the need to manage these risks.

The neutral rate is relevant for understaning the stance of monetary policy and for the fiscal outlook, as it determines the financing conditions for government debt. We explain how the neutral rate is defined, discuss its economic determinants and provide estimates of how it has changed since the pre-pandemic period. Increased government debt supply appears to have excerted substantial upward pressure on the neutral rate.



We make reference to the following papers:

Thiago Ferreira and Samer Shousha titled “The supply of safe assets and global interest rates” , Journal of International Economics, 2023.

Atif Mian, Ludwig Straub, and Amir Sufi. titled “What explains the decline in r*? Rising income inequality versus demographic shifts.” Proceedings of the Jackson Hole Symposium, 2021.

We review the fiscal position of France, Germany, Italy and Spain, discuss the need for consolidation and how it could be implemented with minimal harm to output.

Provided wage growth moderates and inflation develops as expected, the ECB will start cutting interest rates in June. We discuss the uncertainties around this outlook and recent headwinds on the inflation front.

We discuss with Prof. Harald Fadinger (University of Mannheim) how the EU taxes the carbon content of imported goods via its Carbon Border Adjustment Mechanism (CBAM).

We critically review the effectivenes of CBAM to prevent "carbon leakage", i.e., the international reallocation of production to locations with low carbon prices, and its effect on the international competitiveness of EU firms. CBAM appears to perform badly on both of these and a number of other fronts.

We also discuss alternative approaches for international carbon price adjustments, partly based on research by Harald and his coauthors:

"Designing Effective Carbon Border Adjustment with Minimal Information Requirements. Theory and Empirics", by A. Campolmi, H. Fadinger, C. Forlati, S. Stillger and U. Wagner.

We discuss with Veronika Grimm (German Council of Economic Experts) about lifting Germany's long-run growth potential. We focus on measures that increase labor supply, human capital formation and the role of long-run electricity prices.