Eurozone: dreams and the grim reality
A recent statement by the President of the European Central Bank Mario Draghi at the annual meeting of central bankers in Jackson Hole, Wyoming, was of great interest, but the hidden meaning of his remarks was even more striking than many initially thought. If we manage to avoid the disintegration of the euro area, output from the prolonged recession will require increased fiscal deficits, financed by the ECB’s money. The only question is – how this reality will be recognized publicly. Recent economic data have forced politicians to look at the Eurozone serious deflationary risks that were evident at least two years. Inflation stuck well below the target level of annual ECB 2% and GDP stalled. Without decisive policy action Eurozone, like Japan in the 1990s, it will face a lost decade or two painfully slow growth. Until last month, concerns about growth provoked controversial policy proposals. Yens Vaydman, Bundesbank president, has called for higher wages. However, wage growth is not possible without political incentives.
Draghi tried to reduce the rate of the euro at the expense of verbal intervention to increase competitiveness in the region. However, Japan and China also need a competitive exchange rates to boost exports growth and the Eurozone has already accumulated a current account surplus. The German model of growth through exports can not work for the whole euro area as a whole. In some countries, of course, structural reforms are needed to strengthen the growth potential in the long term; However, structural reforms often have a negative impact on short-term growth. The euro area need to boost domestic demand to get rid of excessive debts incurred as a result of the crisis. In countries such as Spain and Ireland, the debt in the private sector have reached unacceptable levels. In other countries, such as Greece and Italy, the national debt was too big, too. To pay the debt, reduced household consumption, business investment and government spending.
However, the simultaneous reduction in the debt burden in the public and private sector is required to limit the demand and growth. Reducing leverage in the private sector in the 1990s, Japan has avoided an even deeper depression, only accumulating a huge public deficit. Therefore, a program of fiscal tightening in the euro zone are doomed to failure. For example, the Italian government has aggressively cut expenditures or raise taxes, the greater the likelihood that its public debt has already exceeded 130% of GDP, reached an unacceptable level. Until recently, the euro area policies deny this reality. Draghi acknowledged this August 22 in Jackson Hole. Without an increase in aggregate demand, structural reforms may be ineffective; and higher demand requires fiscal stimuli, together with the conduct of monetary policy aimed at stimulating growth.
Italian economists, Francesco Dzhiavatstsi and Guido Tabellini explained, which can mean a coordinated fiscal and monetary policies. They offer to cut taxes by 5% of GDP in the next 3-4 years in all countries of the euro area due to the accumulation of public debt in the very long term, which should repay the ECB. They argue that the mere quantitative easing conducted by the ECB, without fiscal easing, would be ineffective. Offers Dzhiavatstsi Tabellini and may require too much stimuli. However, they also raise an important question: how quantitative easing will stimulate the economy? The Bank of England is quantitative easing as a purely monetary policy to support economic growth in the conditions necessary and feasible fiscal consolidation. According to the Bank of England, it works by reducing the medium-term interest rates, increasing the value of assets and the changing preferences of investors, which indirectly stimulates investment and, therefore, demand.
The position of the US Federal Reserve was not so certain. Fed Vice Chairman Stenli Fisher, as well as the former chairman, Ben Bernanke, said that premature fiscal consolidation can hinder recovery after the crisis. Therefore, the Fed indirectly considered quantitative easing, in part, as a means, through the use of which the growth in bond yields can not negate the beneficial effects of large deficits. Position the Fed is more convincing. Fiscal incentives have a direct and strong impact on demand. According to Milton Friedman, they immediately fall into the “current revenue stream.” Only the monetary stimulus do not give immediate results and may cause adverse side effects. Long-term persistence of low interest rates allows unsuccessful companies fight for survival, slowing productivity growth; increasing the value of assets exacerbates inequality; and monetary stimulus are only due to the resumption of growth in private lending, which originally sparked the formation of excess debt.
But if the fiscal stimulus must be accompanied by the purchase of bonds by central banks to prevent an increase in profitability and mitigate concerns about debt sustainability, does not that mean monetary financing of fiscal deficits? The answer depends on whether the regular procurement. In Japan, where the central bank is now owned by government bonds in the amount of 35% of GDP (and this level is rising rapidly), so be it. There is no convincing scenario in which Japan can accumulate a large enough fiscal surplus to pay off a debt: a considerable part will always remain on the balance sheet of the Bank of Japan. Just accepting the offer Dzhiavatstsi and Tabellini would almost certainly lead to a permanent increase in the ECB’s balance sheet.
Whether openly admit this possibility? The argument for this is that otherwise would have intensified fears of a possible payment of the increased government debt, or “withdrawal” from the ECB’s swollen balance, which in turn undermine the stimulating effect of fiscal and monetary coordination. The argument against – moral hazard: if we recognize that moderate deficits, financed by the ECB, is now possible and acceptable, what’s to stop politicians and voters to demand and inflationary large deficits financed by the ECB, in other cases? Of course, high political risks. Consequently, the optimal policy may be accompanied by underhand games; monetary and fiscal “coordination” can mean permanent financial funding, however, open the possibility of never admit. In any case, Draghi strongly promoted this debate forward. Without expanding the role of fiscal policy Eurozone will face a sustained slowdown in growth or a possible decay.
Prepared by Project Syndicate Forexp.ru materials Source: Forexpf.Ru – Forex Market News
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