Draghi has to do, as well as say, whatever it takes

Mario Draghi does his redoubtable best to reassure us: the eurozone recovery, he tells us, is “on track”.

Rather than face the reality of stagnation, the president of the European Central Bank seems to have adopted the leitmotif of Olli Rehn, the former EU economic and monetary affairs chief, who for the past three years has asserted in defiance of all evidence that a turning point was in sight.

At this year’s annual conference of central bankers at Jackson Hole, Mr Draghi should change tack. His promise two years ago to do “whatever it takes” to save the euro captured the attention of markets. Now he should say what he will do to save the economy.

True, Mr Draghi faces an unenviable predicament. Some of his colleagues on the ECB governing council have opposed expansionary measures. ECB policy has therefore been based as much on words as on action. It is understandable that Mr Draghi might want to keep up a brave front. His promise to keep monetary union intact – and his vow that “believe me, it will be enough” – saved the eurozone. This was a huge achievement. But it did not lay the basis for a sustained recovery.

The clouds over the eurozone economy began to accumulate long ago. It is no use blaming unrest in Ukraine and the Middle East for its flagging economic performance. The road to stagnation did not originate in Gaza and Kiev, and there can be no doubt that it runs through Frankfurt and Brussels. Perceptions are important, but you cannot conjure an economic recovery by summoning the confidence fairy. There is no substitute for pragmatic, non-ideological policies that accept and confront the data – which tell us that current policies are failing.

Economic commentators conventionally define a recession as two consecutive quarters of declining output. That narrow definition belies economic reality, however. Under the chairmanship of economist Philippe Weil, the business cycle dating committee at the Centre for Economic Policy Research identifies economic cycles by looking at a wide range of indicators. It has twice warned that the meagre signs of a rebound in the eurozone since early 2013 were not enough to declare the end of the double-dip recession that started in the third quarter of 2011. It signalled concern that the economy could again go into reverse, or that sluggish growth could become the new, dismal normal of the eurozone.



The second quarter data are now in. Most of the optimists are finally silent. The three largest eurozone economies all failed to register growth. Observers are busy revising their output forecasts downward. Inflation is at 0.4 per cent, against an objective of below but close to 2 per cent. This is not a recovery, not even a fragile one. Nor is it a return to recession. It is a continuation of stagnation. We cannot expect that under present policies, and with weak global trade growth, a depreciation in the euro will help much. Nor will the provision of cheap funding under the ECB’s targeted longer-term refinancing operation. A comprehensive assessment of bank balance sheets will, if properly conducted, renew confidence in eurozone lenders, some of which have been under a cloud since the crisis struck in 2008. But this will not in itself lift investment demand.

European citizens must hope that their policy makers, in Frankfurt and in Brussels, will abandon further attempts to reassure us, and abandon their one-sided mantra of structural reform. The acute, pressing problem is aggregate demand.

Repairing the credit system, implementing serious reforms of state expenditure and taxation, creating more flexible labour markets, finally opening the services market to cross-border competition – all are indeed very important. But they will not liberate the eurozone from stagnation.

Lightening the load of debt on private and public sector balance sheets requires a convincing return to growth. That will not come from policies such as raising bank capital and primary fiscal surpluses, which do not stimulate economic activity.

Seriously expansionary monetary and fiscal policies are both necessary and urgent. When will the ECB acknowledge that it is so far from achieving its inflation mandate that the eurozone risks slipping into deflation? When will it do “whatever it takes” to achieve it? Fiscal austerity was intended to bring public sector debt under control. Yet debt-to-GDP ratios have actually risen as a result. When will the commission acknowledge that its strategy has failed?

Much has been said about the need to maintain the credibility of European monetary institutions. Too often, that has been an excuse for inaction. Yet a return to economic growth is what is needed to restore credibility. Failure and continued stagnation could destroy the ECB, the European Commission, and the European project.



Richard Portes is professor of economics at London Business School. This article was written with Philippe Weil of Université Libre de Bruxelles



Fonte: FT