We have tried to transpose these challenges to the countries in the region, as in some of them economic boundaries for the monetary policy are lesser compared to the ECB, given positive policy rates. Our simple analysis shows that financial vulnerabilities, observed through the leverage of the public and private sector, seem to be contained, despite the loose financial conditions. Sovereign  17  debt has decreased in the last couple of years, indicating that countries use the benign financial conditions for creating more fiscal space. Private leverage is well below some of the accepted benchmarks. Yet in many of the countries, given the low interest rate environment, household credits are on a rising path, and potential risks are addressed through macro-prudential measures. Hence, some vigilance is needed, with respect to build-up of financial vulnerabilities, though they seem to be much lesser in the region compared to the more advanced economies. Inflation dynamics and its drivers seem to resemble those in the euro area, asking for more profound scrutiny of prices, before proceeding with monetary loosening. At the current juncture, it seems that despite the monetary policy space which exists in part of the region, further policy cuts should be carefully calibrated and considered in the context of country specific assessment of future financial and inflation risks. References: 1. Aleksandra Riedi “Household debt in CESEE economies: a joint look at macro- and micro-level data”, Focus on European Economic Integration, 2019, issue Q1/19. 2. Bank of Spain. 2019.
A warehouse cannot easily or cheaply be turned into an office building; if a manufacturing company installs an extra production line, and demand for its product subsequently weakens, it can’t then choose to lease the line to another firm; the same is true of specialised software for a bank or insurance company. Clearly, this “sunk-cost” property of investment spending may in practice apply to some types of capital more than others. What we do know is that, without it, economic theory would have a hard time explaining why greater uncertainty depresses investment to the degree it does – or even at all. 3 Conversely, once you do take it into account, the predicted effects can be quite powerful. Investment projects that would otherwise make a great deal of sense – because the income they’re expected to generate easily exceeds the costs of financing them – will be avoided, or at least postponed, if the reversal costs are high enough and the uncertainty about those returns sufficiently acute. Instead, it often makes sense to wait until the expected value of the project is sufficiently high that it covers not just the direct cost of the project but an extra margin of safety on top, something economists have called the “option value of waiting”: Return on investment > cost of finance plus option value of waiting  [1]  The greater this margin, the higher the profitability required of any new investment. As this hurdle rate goes up the number of new projects that can meet it declines.