Last week’s decision by the European Central bank (ECB) to maintain current interest rates at 0.5%
was no surprise. Market expectations were that there would not be sufficient support for additional monetary accommodation.
Still, European markets reacted positively, because the ECB’s President, Mario Draghi, also announced that he expected
interest rates to remain at such record low levels for a while.
It is the reasoning by the
Governing Council of the ECB that seems troubling as it ignores the fundamental structural crisis reverberating through the
As Mr. Draghi stated, real GDP in the Eurozone fell by 0.3% in the first quarter
of 2013. He failed to note, however, that this contraction is very asymmetric and that it has lasted for up to five years
in some of the member states. Furthermore and throughout the statement as well in answering questions from the press, Mr.
Draghi did not truly acknowledge the structural nature of this permafrost, but continued to treat the recession as
if it were cyclical. In fact, he pointed out that “recent developments in cyclical indicators … indicate some
improvements from low levels”.
Obviously, nothing could be further from the truth.
In fact, the only reasonable justification for the Governing Council’s inaction on interest rates, not to speak of quantitative
easing, is if the ECB underlined – correctly – that the crisis is structural not cyclical in nature, which renders
low interest rates and the injection of more liquidity largely ineffectual.
Of course, admitting
the structural nature of the crisis and, hence, the limited effectiveness of monetary policy would then have to lead the Council
and Mr. Draghi to encourage expansionary fiscal policy in the Eurozone. However, such encouragement is a political taboo given
adamant German opposition to Keynesian policies.
Furthermore, it is very unsettling that the Governing
Council continues to be absorbed by inflationary prospects. It is true that the Charter of the ECB provides that price stability
is the only major mandate for the central bank, but given chronically low inflation rates in the Eurozone, one might wish
that the bank focus on other aspects for the economic standstill.
Moreover, the Governing
Council did not even mention core inflation (excluding food and energy prices). If it did, the picture would be far more concerning,
highlighting the imminent risk of deflation as well as a medium-term growth outlook for the Eurozone not unlike Japan’s
experience since the early 1990s.
Mr. Draghi’s hopes of a pickup in growth are
solely pinned on a miraculous recovery everywhere else in the world in 2014 in order to increase the Eurozone’s exports.
It is the ultimate dream of Eurozone policy-makers that every member country accrue current account surpluses just like Germany.
But it is a fantasy to believe that all countries in the world can run such surpluses. The global balance sheet of all imports
and exports has to show the same number on both sides of the ledger.
To make things worse,
Mr. Draghi expects domestic demand in the Eurozone to grow due to “recent gains in real income owing to generally lower
inflation.” This is most certainly a recipe for deflation.
The Governing Council also
gave no explanation for its assertion that fiscal consolidation and balance sheet repairs would “work their way through
the economy”. This is in stark contrast to the numbers on credit growth (or rather contraction) that Mr. Draghi shared.
Credit to non-financial corporations fell more in May 2013 (-2.1%) than in April (-1.9%).
are hardly “green shoots”, which Fed Governor Ben Bernanke once famously and mistakenly saw sprouting in the U.S.
economy in 2009. Moreover, this contraction of credit against the background of loose monetary policy indeed confirms
that the current crisis is not one of lack of “supply” (cured by injection of liquidity or in other words through
monetary policy), but lack of “demand” (addressed primarily by fiscal expansion).
Germany, the Governing Council’s dominant force is deeply wedded to supply-side economics, even when it is not applicable.
To be sure, both Milton Friedman and John Maynard Keynes have made good, albeit largely opposing, arguments. In fact, the
disciples of Friedman and Keynes are doing a disservice to their teachers by claiming exclusivity of either monetary or fiscal
policy in solving problems. Both have their place and time in managing economies. It just so happens that this crisis is a
All-in-all, the Governing Council’s statement failed on July 4th,
once again, to identify the core reasons for the crisis. It is understandable that the ECB, as the key representative of the
monetary union, cannot acknowledge the flaws of this union and the political inability to address these flaws effectively,
expeditiously and with finality.
That being said, the ECB should not treat this chronic
crisis as business as usual. Political destabilization and social erosion is spreading throughout many countries of the Eurozone.
Last week’s political crisis in Portugal is just the latest reminder of that and it will not
be the last. Never-ending austerity with unemployment numbers and youth unemployment numbers in some countries above those
experienced during the Great Depression are simply unsustainable and will have grave political consequences. The demonstrated
emotional detachment of technocrats from these brutal realities only enhances peoples’ distrust of the legitimacy of
An outright acknowledgement by the ECB of the deeply structural nature of the crisis,
rather than being caught up in cyclical analysis, would have gone a long way.
of Mr. Draghi that he address potential political solutions to this situation. Such solutions would include the mutualization
of Eurozone debt or debt forgiveness by the so-called troika of creditors (the European Union, the ECB and the International
Monetary Fund) as well as quick and permanent surrender of sovereignty by all Eurozone members in fiscal affairs as well as
control of their banking systems.
Failing to truly make inroads on these issues instead of
issuing pointless summit resolutions means that we will hobble along with no exit to the crisis in sight, while patching up
the potholes in the road of the Eurozone economy. Eventually, that will prove to be too little. The only question that remains,