ECB keeps its head in the sand as German economy contracts

Draghi, where are you?

The Economist's Ryan Avent has made waves with a well-timed punchy question: why are we acting like the fact that the eurozone hasn't actually imploded means everything is alright there?

Some perspective is in order. Real euro-area output is at roughly the level of the end of 2006 and it is declining. The euro-area economy hasn't grown since the third quarter of 2011. Total employment is below the level first attained in the second quarter of 2006 and it is declining. The unemployment rate is of course at a record high 11.8%. And inflation—both core and headline—was virtually nil in the second half of 2012.

That's simply a dismal macroeconomic performance.

The European Central Bank deserves some credit for having halted the repeated attacks on the currency — and perhaps that credit should go to the president of the bank, Mario Draghi, himself. His declaration last July that the euro would be preserved "whatever it takes" is widely held to have been the turning point at which the survival of the euro was assured.

But the ECB's target should be higher than merely ensuring the continued existence of the currency it was created to oversee. And it's not just that the bank is trying, but failing, to boost demand in the eurozone. It has done, essentially, nothing. Interest rates remain well above even the zero-bound where conventional monetary policy falls apart, and its unconventional measures — which it was happy to employ when it was in a do-or-die situation — have been non-existent.

According to statistics released yesterday, Germany contracted by 0.5 per cent in the fourth quarter last year. Germany! That's the country that's supposed to be the beating heart of the eurozone. It's one thing when the analysis was that the ECB was unfairly trading Greek health for Germany; but based on who's being touted as success stories these days, you'd be forgiven for thinking that it's trading German health for Estonian. (Estonian GDP grew by 8 per cent in 2011, but that still left it 9 per cent below its pre-crisis peak — it's certainly not an unambiguous success story).

Draghi is apparently hoping that global growth will sweep in and restore the European economy from without, and that all he needs to do is keep it ticking over until then. But the job of a central bank governor is not to wait for dei ex machinae. And given the size of the eurozone, it may be rather hopeful to conclude that the is such a thing as a separate worldwide economy. Can the rest of Europe have a proper recovery with the eurozone depressed? What about the economies of North America, or Japan?

There's a temptation, especially on the part of those pessimistic about the EU in general, to throw their hands up and declare the situation irreconcilable. But despite — maybe because of — the ECB failing to even recognise there's a problem, it's not clear that it has no possible solutions. Once it gets its head out of the ground, maybe it will realise there are things it could have been doing all along.

Photograph: Getty Images

Alex Hern is a technology reporter for the Guardian. He was formerly staff writer at the New Statesman. You should follow Alex on Twitter.

Photo: Getty Images
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There are risks as well as opportunities ahead for George Osborne

The Chancellor is in a tight spot, but expect his political wiles to be on full display, says Spencer Thompson.

The most significant fiscal event of this parliament will take place in late November, when the Chancellor presents the spending review setting out his plans for funding government departments over the next four years. This week, across Whitehall and up and down the country, ministers, lobbyists, advocacy groups and town halls are busily finalising their pitches ahead of Friday’s deadline for submissions to the review

It is difficult to overstate the challenge faced by the Chancellor. Under his current spending forecast and planned protections for the NHS, schools, defence and international aid spending, other areas of government will need to be cut by 16.4 per cent in real terms between 2015/16 and 2019/20. Focusing on services spending outside of protected areas, the cumulative cut will reach 26.5 per cent. Despite this, the Chancellor nonetheless has significant room for manoeuvre.

Firstly, under plans unveiled at the budget, the government intends to expand capital investment significantly in both 2018-19 and 2019-20. Over the last parliament capital spending was cut by around a quarter, but between now and 2019-20 it will grow by almost 20 per cent. How this growth in spending should be distributed across departments and between investment projects should be at the heart of the spending review.

In a paper published on Monday, we highlighted three urgent priorities for any additional capital spending: re-balancing transport investment away from London and the greater South East towards the North of England, a £2bn per year boost in public spending on housebuilding, and £1bn of extra investment per year in energy efficiency improvements for fuel-poor households.

Secondly, despite the tough fiscal environment, the Chancellor has the scope to fund a range of areas of policy in dire need of extra resources. These include social care, where rising costs at a time of falling resources are set to generate a severe funding squeeze for local government, 16-19 education, where many 6th-form and FE colleges are at risk of great financial difficulty, and funding a guaranteed paid job for young people in long-term unemployment. Our paper suggests a range of options for how to put these and other areas of policy on a sustainable funding footing.

There is a political angle to this as well. The Conservatives are keen to be seen as a party representing all working people, as shown by the "blue-collar Conservatism" agenda. In addition, the spending review offers the Conservative party the opportunity to return to ‘Compassionate Conservatism’ as a going concern.  If they are truly serious about being seen in this light, this should be reflected in a social investment agenda pursued through the spending review that promotes employment and secures a future for public services outside the NHS and schools.

This will come at a cost, however. In our paper, we show how the Chancellor could fund our package of proposed policies without increasing the pain on other areas of government, while remaining consistent with the government’s fiscal rules that require him to reach a surplus on overall government borrowing by 2019-20. We do not agree that the Government needs to reach a surplus in that year. But given this target wont be scrapped ahead of the spending review, we suggest that he should target a slightly lower surplus in 2019/20 of £7bn, with the deficit the year before being £2bn higher. In addition, we propose several revenue-raising measures in line with recent government tax policy that together would unlock an additional £5bn of resource for government departments.

Make no mistake, this will be a tough settlement for government departments and for public services. But the Chancellor does have a range of options open as he plans the upcoming spending review. Expect his reputation as a highly political Chancellor to be on full display.

Spencer Thompson is economic analyst at IPPR