ECB's latest move won't work

ECB's latest move won't work

ECB's latest move won't work

Draghi never disappoints. In his penultimate monetary-policy meeting, the still President of the ECB announced that the Eurozone’s central bank would soon resume the net asset purchase program in an attempt to get inflation back to the ECB’s 2 percent target after some months of lower-than-expected inflation. The Governing Council also agreed to lower the deposit rate to -0.5%, although a considerable fraction of banks’ excess reserves will be exempt from paying interest thanks to the new two-tier system introduced by the ECB.

At first sight, this might seem more of the same. The ECB started purchasing euro-denominated government bonds in early 2015, expanding its asset purchase program to include corporate bonds one year later. In December 2018, after almost four years, the Governing Council agreed to halt net purchases. Yet this time is different. Although of smaller size in comparison with previous QE rounds, the one that will begin on November 1st  is open-ended, which sends a reassuring message to both governments and the private sector that expansionary monetary policy will continue as long as needed.

Another key aspect that makes this new stimulus package different from previous ones is the lack of consensus in the Governing Council, the body in charge of setting the guidelines of monetary policy. According to the Financial Times, 36 percent of the members of the Council showed their disagreement with the decision. This by no means insignificant division in the heart of the ECB’s decision-making body could end up jeopardizing Christine Lagarde’s plans to continue with Draghi’s accommodative monetary policy.

What can we expect from this aggressive monetary-policy move? Not much. And Draghi knows it. As he suggested in the after-meeting press conference, this last-ditch effort to give a boost to the Eurozone’s ailing economy is useless unless Eurozone countries carry out expansionary fiscal policies and growth-enhancing structural reforms. Yet, as pointed out by Draghi himself, the lack of fiscal space in those countries that would need them makes the use of fiscal policy a chimera.

In any case, fiscal policy cannot bring about long-term economic growth, so the conduct of reforms is the only policy tool that countries can resort to to secure the economy will continue to grow in the near future. The European Commission recently threw out some ideas of which reforms should be prioritized.

For countries like Spain or Italy, the priority should be to keep government expenditure under control and reduce their respective public debt to GDP ratios. Creating a business-friendly environment that encourages companies to increase their R&D spending (which is currently half the level of the Eurozone in both countries) would no doubt increase long-term economic growth in these countries.  In the case of Spain, a more flexible labor market would help reduce the high structural unemployment the country has suffered in the last four decades.

For its part, France should focus on simplifying its tax system and reducing the burdensome regulatory framework towards the business sector. Germany’s low economic growth, however, has to do more with Trump’s trade war than with the need for reforms, although the Commission suggests that competition-strengthening policies or lowering the current tax wedge would enhance economic growth in the Central European country.

There is no doubt that these reforms would foster economic growth in these respective countries. Yet there are some structural, underlying factors that are negatively affecting the Eurozone economy and cannot be tackled on a country-to-country basis. The main challenge is population aging, which has been shown to be a significant factor in reducing economic growth in the long run. The introduction of a comprehensive reform in the European Union aimed at reducing migration barriers would help mitigate the harmful effects of population aging.

The ECB’s latest attempt to revitalize the economy via expansionary policies will inevitably fail unless countries take the need for reforms seriously. Some even suggest that the endless monetary expansion that began in 2015 could result in the zombification of the economy: unprofitable firms, which survive due to easy credit conditions, crowd out investment opportunities of productive firms, with the subsequent negative impact on the economy.

Be that as it may, we must never forget that economic growth (and thus, living standards) doesn’t depend on fiscal and monetary policy, but on the capacity of businesses to increase productivity via innovation.

Luis Pablo de la Horra

Luis Pablo de la Horra
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