from 24.0 in 2013 percent to 16.8 percent in 2017 (the overall unemployment rate fell from 9.5 percent to 6.7 percent over this period).4 Average inflation in the western part of the region has been almost 2 percent since early 2017 (figure 1.4). That is a critical change from the deflationary threats in the aftermath of the European banking crises.
Between 2012 and 2016, the consumer price index declined in at last one year in Armenia, Bosnia and Herzegovina, Bulgaria, Croatia, Cyprus, Estonia, Finland, Georgia, Greece, Ireland, Italy, Lithuania, Macedonia, Montenegro, Poland, Romania, the Slovak Republic, Spain, Sweden, and Switzerland. In several of these countries, the GDP deflator still rose, and the drop in consumer prices reflected terms-of-trade gains. Nevertheless, the deflationary threat was a serious concern and the manifestation of underutilized resources. None of these countries experienced deflation in 2017.
The average inflation rate of 2 percent is close to the target of monetary authorities. As a result, the European Central Bank will likely discontinue quantitative easing in 2018; central banks outside the euro area are also expected to tighten their policies. Tightening has already started in Turkey, where inflation has reached double-digit levels. Asset prices have risen even faster than consumer prices (figure 1.5). The increase in real estate prices is not nearly as extreme as it was during the boom a decade ago, but in Northern Europe double-digit annual increases were not uncommon in 2017. This boom is an additional reason for monetary policy makers to raise interest rates. In the eastern part of the region, monetary policies are likely to tighten in coming years, even as inflation has recently fallen (figure 1.4).
High inflation in 2015 and 2016 was part of a one-time price adjustment after the fall in oil prices and the subsequent unavoidable depreciations of exchange rates. That adjustment FIGURE 1.4 Normalization of inflation in Europe and Central Asia continues –1 0 1 2 3 4 5 6 7 8 9 2013M01 2013M08 2014M03 2014M10 2015M05 2015M12 2016M07 2017M02 2017M09 2018M04 Eastern ECA Western ECA Percentage change over three-month average in previous year Source: World Bank. Note: Western ECA is the unweighted average of 29 countries: Albania, Austria, Belgium, Bulgaria, Bosnia and Herzegovina, Croatia, the Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Luxemburg, Latvia, Macedonia, the Netherlands, Portugal, Romania, Serbia, the Slovak Republic, Slovenia, Spain, Sweden, the United Kingdom, and Turkey. Eastern ECA is the unweighted average of nine countries: Armenia, Azerbaijan, Belarus, Georgia, Kazakhstan, the Kyrgyz Republic, Moldova, the Russian Federation, and Tajikistan. Chapter 1: Economic Developments and Prospects ● 9 has been completed.
Further inflation should now be controlled by central banks, which have to build their credibility with floating exchange rates. Now that oil prices are recovering, tighter monetary policies make sense, as they can allow higher prices to be absorbed by appreciating currencies. Tighter monetary policy and rising interest rates will restrain domestic growth and reduce capital flows to emerging economies. The capital flows that were searching for yields in emerging economies
when interest rates in high-income countries were close to zero will likely decline, moderating growth in countries with large external funding needs. In such an environment, a cyclical downturn is more likely than further acceleration or even stabilization of growth at current levels. That slowdown may already be happening. The Purchasing Managers’ Index, which combines various indicators in the manufacturing sector (new orders, inventory levels, production, deliveries, employment), has fallen in the region since the beginning of 2018 (figure 1.6, panel a). The drop from the peak reached in the last six months was particularly large in France,
Germany, Italy, Turkey, and the United Kingdom, even if the index was still above 50, indicating growth (figure 1.6, panel b). The coming cyclical downturn is expected to be modest, mainly because, with few exceptions, there are no signs of overheating that require sharp corrections. Investment ratios are still at balanced levels, and no steep declines in those ratios are expected. Inflation is at normal levels, and monetary tightening can be very gradual. GDP growth for the region is expected to fall from 2.7 percent in 2017 to 2.3 percent in 2018 and 2.1 percent in 2019. The expected slowdown is very similar for the eastern and western parts of the region.
However, there are marked differences between smaller subregions. In the eastern part of the region, almost all the slowdown in growth is forecast to come from Turkey, with a modest strengthening of growth in oil-exporting countries. In the western part of the region, the slowdown is expected to be rather evenly distributed among members of the European Union, and some acceleration of growth is expected in the Western Balkans. FIGURE 1.5 Housing prices in the European Union have risen since 2013 –8 –4 0 4 8 12 2006Q1 2007Q2 2008Q3 2009Q4 2011Q1 2012Q2 2013Q3 2014Q4 2016Q1 2017Q2 Annual percentage growth Nominal housing prices Housing prices deflated with CPI Sources: Data from Eurostat and the Federal Reserve Bank of St. Louis. 10 ● World Bank ECA Economic Update May 2018 Although there are good reasons to expect only a modest deceleration of growth, a sharper correction is possible. Cyclical forces can easily reinforce one another, and additional shocks—including rising protectionism, geopolitical tensions, and larger than expected disruptions from Brexit—could slow growth. Does the region have the capacity for countercyclical policies? There is no room for further monetary stimulus; at most, the expected monetary
tightening could be delayed slightly. The region has rebuilt some fiscal buffers. The average fiscal deficit is estimated to have been just above 1 percent of GDP in 2017, down from 6 percent of GDP during the 2009 crisis; it is close to levels at the end of the boom that preceded that crisis (figure 1.7). Fiscal stimulus is thus an option in several countries in the event of a sharper than expected slowdown. Under the baseline scenario of only a modest deceleration, further buildup of fiscal buffers seems the best strategy. FIGURE 1.6 The Purchasing Managers’ Index reached an all-time high in Europe and Central Asia in 2018 44 46 48 50 52 54 56 58 60 2014M01 2014M07 2015M01 2015M07 2016M01 2016M07 2017M01 2017M07 2018M01 Index value Europe and Central Asia World 45 47 49 51 53 55 57 59 61 63 65 Czech Republic France Germany Hungary Italy Poland Russian Federation Spain Turkey United Kingdom Index value March 2016 March
2018 Max October 2017–March 2018 a. Recent weakening was stronger in Europe and Central Asia The region has shifted toward more exports. . . The biggest and most important adjustment during the recovery has been the shift of production capacity toward exports. Despite the slowdown in global trade, the share of exports in GDP is now 10 percentage points higher than it was during the 2000s (figure 1.8). This shift is important, because the economic structure during the 2003–07 boom, when growth in many countries in the region was driven largely by expansion of nontradable sectors, was no longer sustainable. During that boom, capital inflows,
oil revenues, and inflows of remittances resulted in increased domestic spending and a related loss in international competitiveness. In the new normal after the crisis, all three forms of foreign inflows are more moderate.
The change has created the opportunity to become more competitive in international markets while reducing investments in real estate and other nontradable sectors. Imports have also increased as a share of GDP, albeit by less than exports. The overall current account surplus of the region has thus increased, largely because the deficits that Central European countries financed with massive capital inflows during the boom have disappeared. These inflows came with a sharp decline in investment ratios in those countries. This adjustment is similar to the correction in East Asia after the 1998 financial crisis (box 1.1). During the 1990s, emerging East Asian economies received large capital inflows after they opened up to global markets, just as Central Europe did later, during the 2000s. The reversal of capital flows in 1998 had similar effects on East Asia as the 2008 crisis did on Central Europe.
• Other potential applications of blockchain technologies, from smart contracts to decentralized databases and open source social networks, could well become more transformational than cryptocurrencies. Current experiments are likely to result in lasting innovations, even if current applications do not stand the test of time. • The emergence of blockchain technologies has triggered a flurry of activities in Europe and Central Asia (ECA), where people use cryptocurrencies for cross-border transactions and as speculative investments. Start-up companies are mining cryptocurrencies and providing blockchain services. Governments are experimenting with blockchain technologies to make their services more secure and more transparent. •
Many factors provide a fertile ground for these activities in ECA. Several governments actively support innovation by start-ups. Governments are eager to digitize and streamline their services. Lack of trust in existing financial intermediation makes cryptocurrencies an interesting alternative in some countries. Cryptocurrencies are also used to sidestep oversight of cross-border transfers. Cheap electricity (in Iceland and Georgia, for example) entices the mining of cryptocurrencies. • Cryptocurrencies and blockchain technologies pose a range of policy challenges. They include the need to (a) apply rules of financial oversight, consumer protection, and tax administration while at the same time encouraging and facilitating innovation;
(b) deal with the massive volume of electricity used to mine cryptocurrencies; and (c) determine whether governments and central banks can use blockchain technologies to improve their services. Policymakers should find a balance between curbing the hype and unleashing potentially transformational new opportunities. International coordination is needed to share best practices, avoid regulatory arbitrage, and explore how to regulate global decentralized networks. Introduction Ten years after an ingenious experiment to create a cryptocurrency that allows secure and anonymous digital transactions to take place without the involvement of central banks or commercial banks, cryptocurrencies have become a multibillion-dollar industry.
By December 2017, the average price of one bitcoin (the first cryptocurrency) had risen from just a few cents in 2009 to $15,000, doubling its value in a single month. These gains attracted many investors across the world. On December 1, 2017, the U.S. Commodity Futures Trading Commission approved trading in bitcoin futures. Although the price of a bitcoin had declined to about $8,000 in April 2018, the value of bitcoins in circulation was about $150 billion as of April 10, 2018. Big companies, and individuals working together in large pools, are competing for the right to add new transactions to the existing chain of transactions. Their revenues, in the form of new bitcoins and transaction fees, are close to $20 million a day. Chapter 2: Cryptocurrencies and Blockchain:
Hype or Transformational Technologies? ● 23 In the wake of bitcoin’s success, hundreds of alternative cryptocurrencies have been created. Digital tokens have been issued as general currency; for specific purposes (for example, to rent computer capacity or cloud storage); and as an alternative to traditional shares in companies. Cryptocurrencies have evoked strong reactions. Critics call these virtual currencies a bubble, a scam, and even evil (Krugman 2013; Popper 2018). Supporters predict that cryptocurrencies will ultimately replace money (Rooney 2018).
There is less disagreement about the underlying blockchain technology, a protocol to achieve decentralized consensus about the validity of a common database, stored in multiple locations. Many recognize that the blockchain protocol can lead to tamper-proof, secure information systems without the need for a single administrator. But even here views differ markedly about how transformational this technology is. Believers foresee utopian societies of self-regulating individuals, without government or trusted intermediaries. Doubters argue that the number of useful applications has been exaggerated, that lack of regulation can have disastrous effects, and that in most cases trusted intermediaries will continue to provide useful services.
It is unclear how these technologies will develop in the long run. Conceivably, they could be absorbed by existing institutions, with central banks issuing digital cash, governments using blockchain to maintain information systems, and commercial banks putting payment systems on the blockchain.1 Many intermediaries might become obsolete, and many new financial instruments might be created by companies that do not yet exist. The main legacy of cryptocurrencies may not be the blockchain technology but standardized digital IDs using a combination of public and private keys on open-source software.2 Such a development would allow individuals to own more of their data, instead of participating in proprietary information networks (Johnson 2018).
Whatever the future brings, cryptocurrencies and blockchain protocols are part of a tidal wave of new technologies that is changing the way production and commerce are organized. Digital platforms, the sharing economy, apps, and 3D printers are fragmenting production and facilitating P2P transactions. Many of these new applications originated soon after the global financial crisis of 2008, when the bankruptcies of established companies convinced many people that the economy would never be the same again. Investors were looking for new investment opportunities.
Workers who had lost their jobs were willing to accept more flexible working relations. Consumers were persuaded to use some of their underutilized assets commercially. The fact that bitcoin was created in 2009, soon after the crisis, was probably no coincidence. Trust in financial institutions had eroded, and the time was ripe to explore fundamentally different approaches. Whatever the future of cryptocurrencies and blockchain technologies may be, the trends toward decentralization and P2P transactions are unmistakable. Cryptocurrency and blockchain activities are widespread in Europe and Central Asia (ECA). Massive mining of cryptocurrencies takes place in Iceland, Sweden, and Georgia. Many Russians own digital wallets, and experiments are ongoing in Serbia and Tajikistan to use blockchain technology to make the sending of to thr moon...,
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