On 12 September, the outgoing European Central Bank (ECB) president, Mario Draghi, announced that he would cut interest rates and continue the central bank’s bond-buying programme. This was in response to the looming recession in Europe and has triggered a fierce debate in the Eurozone between monetary hawks and doves, as well as EU politicians and technocrats, over the role of monetary policy in the post-crisis world.
Draghi’s announcement is another sign that Europe may be headed the way of Japan, whose economy has been propped up for nearly two decades by an unending quantitative easing (QE) programme. In the wake of the collapse of its own housing bubble in 1991, the Bank of Japan first started exchanging digitally-created money for government bonds in 2001. The central bank’s balance sheet has now reached 100 per cent of GDP.
In the immediate aftermath of the 2008 financial crisis, few central bankers foresaw such an outcome for Europe. Central banks in the US, the UK and Europe assured onlookers that QE would be a temporary measure to boost lending. Many economists at the time, such as Richard Murphy, were sceptical that central banks’ coordinated easing programmes would affect the economies in which they were deployed by raising bank lending – instead they argued that QE might help to prop up demand by boosting asset prices.
The sceptics were right. There is now strong evidence that QE works by boosting asset prices. Central bank purchases have a direct impact on bond yields and also encourage investors to rebalance their portfolios towards other assets, such as equities or corporate bonds. The resulting surge in demand for these assets has increased equity prices, depressed corporate bond yields and pushed up real estate values in some cities.
In other words, QE has made the wealthy wealthier. Perhaps if states had tried, and failed, to boost output and inflation through expansionary fiscal policy (spending rises and tax cuts), it would have been legitimate for them to attempt a programme of money creation that boosted asset prices as a last resort. But in the Eurozone, as in the UK, government spending has been squeezed even as central bankers have created trillions of dollars’ worth of new money.
The Eurozone’s Stability and Growth Pact prevents member states from running deficits greater than 3 per cent of GDP, and limits government debt to 60 per cent of GDP. Historically, these limits have rarely been enforced – they certainly weren’t enforced on France and Germany when they broke these rules in 2003. But the sovereign debt crisis has given the EU a new way of constraining Eurozone states’ government spending by making the imposition of persistent austerity a condition of access to emergency lending.
The natural outcome of this process has been the institutionalisation of deflation across the Eurozone: the rules that govern the bloc systematically encourage states to pursue deflationary macroeconomic policies. And indeed, this is exactly what they were intended to do. Countries like Greece have been told that the only way to boost their competitiveness is to endure a painful period of deflation that has left millions without access to basic necessities such as food and medicine.
The combination of loose monetary policy and tight fiscal policy is making the rich richer and the poor poorer. These combined policies are also failing to achieve their stated objectives – inflation is still far below the ECB’s 2 per cent target, and the entire Eurozone is about to tumble into a painful recession.
So when Draghi announced another wave of interest rate cuts and QE, it is perhaps unsurprising that he accompanied it with a plea for national governments to loosen the purse strings. The problem is Germany. Comfortable with its vast current account surplus and balanced budget, it refuses to countenance an investment-led response to the current economic crisis.
With Germany – very obviously the hegemonic power in Europe – prioritising the maintenance of its own current account and budget surpluses over reducing inequalities between Eurozone states, it is not hard to see why support for anti-EU parties is rising across the continent. And not only is Germany’s myopia causing economic and political turmoil, it is also standing in the way of an EU-wide Green New Deal that is desperately needed to address the climate crisis.
Some onlookers have reacted angrily – the chief executive of the German insurer Allianz has accused Draghi of “politicising” monetary policy. But if one thing has been made very clear since 2008, it is that monetary policy is inevitably political.
The only route out of the post-crisis stagnation, and the only way to rebalance the competitiveness gap between the north and south of the currency bloc, is for Eurozone states to undertake a huge coordinated programme of investment. The ECB’s “overreach” is only necessary as a result of a deliberate failure of national governments, and the Eurozone as a whole, to countenance such an option.
The looming recession will make these issues even more salient. Several quarters of negative growth will not merely exacerbate Europe’s economic problems; it may lead to the break-up of the European project altogether. But don’t expect European leaders to change course any time soon.