Euro in greater peril than at peak of crisis
If there is one thing European policymakers agree on, it is that the survival of the euro is no longer in doubt. The economy is not doing great, but at least the crisis is over.
I would challenge that consensus. European policymakers tend to judge danger in terms of the number of late-night meetings in the Justus Lipsius building in Brussels. There are definitely fewer of those. But that is a bad metric.
I do not have the foggiest idea what the probability of a break-up of the euro was during the crisis. But I am certain that the probability is higher today. Two years ago forecasters were hoping for strong economic recovery. Now we know it did not happen, nor is it about to happen. Two years ago, the eurozone was unprepared for a financial crisis, but at least policy makers responded by creating mechanisms to deal with the acute threat.
Today the eurozone has no mechanism to defend itself against a drawn-out depression. And, unlike two years ago, policy makers have no appetite to create such a mechanism.
As so often in life, the true threat may not come from where you expect — the bond markets. The main protagonists today are not international investors, but insurrectional electorates more likely to vote for a new generation of leaders and more willing to support regional independence movements.
Austerity is here to stay. Fiscal policy will continue to contract as member states fulfil their obligations under new European fiscal rules
In France, Marine Le Pen, the leader of the National Front, could expect to win a straight run-off with President François Hollande. Beppe Grillo, the leader of the Five Star Movement in Italy, is the only credible alternative to Matteo Renzi, the incumbent prime minister. Both Ms Le Pen and Mr Grillo want their countries to leave the eurozone. In Greece, Alexis Tsipras and his Syriza party lead the polls. So does Podemos in Spain, with its formidable young leader Pablo Iglesias.
The question for voters in the crisis-hit countries is at which point does it become rational to leave the eurozone? They might conclude that it is not the case now; they might oppose a break-up for political reasons. Their judgment is prone to shift over time. I doubt it is becoming more favourable as the economy sinks deeper into depression.
Unlike two years ago, we now have a clearer idea about the long-term policy response. Austerity is here to stay. Fiscal policy will continue to contract as member states fulfil their obligations under new European fiscal rules. Germany’s ‘stimulus programme’, announced last week, is as good as it gets: 0.1pc of gross domestic product in extra spending, not starting until 2016. Enjoy!
What about monetary policy? Mario Draghi said he expected the balance sheet of the European Central Bank to increase by about 1tn euros. The president of the ECB did not set this number as a formal target, but as an expectation — whatever that means. The most optimistic interpretation is that this implies a small programme of quantitative easing (purchases of government debt). A more pessimistic view is that nothing will happen and that the ECB will miss the 1tn euros just as it keeps on missing its inflation target. My expectation is that the ECB will meet the number — and that it will not make much difference.
And what about structural reforms? We should not overestimate their effect. Germany’s much-praised welfare and labour reforms made it more competitive against other eurozone countries. But they did not increase domestic demand. Applied to the eurozone as a whole, their effect would be even smaller as not everybody can become simultaneously more competitive against one another.
Two months ago Mr Draghi suggested the eurozone fire in three directions simultaneously — looser monetary policies, an increase in public sector investments and structural reforms. I called this the economic equivalent of carpet-bombing. The response looks more like an economic equivalent of the Charge of the Light Brigade.
These serial disappointments do not tell us conclusively that the eurozone will fail. But they tell us that secular stagnation is very probable. For me, that constitutes the true metric of failure.
Published in Dawn, Economic & Business, November 17th, 2014
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