Clueless in Europe
Despite a slowing Chinese economy, decelerating inflation and a stronger euro, European Central Bank President Mario Draghi has said he will do more to support euro-area growth only “if necessary.” He should stop listening to Europe's scolds and do the right thing.
This op-ed was originally published in Bloomberg View.
Ben Bernanke, the former chairman of the U.S. Federal Reserve, has reminded us that in November 2010, German Finance Minister Wolfgang Schaeuble described U.S. monetary policy as “clueless.” The Fed had decided to step up purchases of Treasury securities to help lower long-term interest rates, in an effort to ward off a small risk of debilitating deflation. Schaeuble described the move as a “sly” effort to weaken the dollar, apparently forgetting how an undervalued euro was boosting Germany’s trade surplus and weakening global growth.
Schaeuble’s intemperate language illustrates a mindset that is blocking debate of European policy priorities and the economic myths that sustain them. The groupthink was evident as early as 2008, when the financial crisis rendered banks on both sides of the Atlantic desperately in need of capital and short-term loans. Joaquin Almunia, the European commissioner for monetary affairs, portrayed it as a U.S. problem, saying that “we are well prepared to weather this situation.” Jean-Claude Juncker, who headed the group of euro area finance ministers, was more belligerent: “We have to be concerned, but a lot less than the Americans, on whom the deficiencies against which we have warned repeatedly are taking bitter revenge.”
The European thinking proved disastrously wrong. In generously restrained words, Bernanke points out that U.S. gross domestic product is 9 percent above its pre-crisis level, while euro area GDP remains 0.8 percent below. He could have added that Schaeuble also warned that the Fed would stoke runaway inflation. The Fed’s preferred measure of inflation remains below its target. The central bank recognized that the real danger was deflation, which needed to be preempted.
In contrast, the European authorities have wallowed in denial. In mid-2010, when asked about the dangers of deflation, then European Central Bank President Jean-Claude Trichet said: “I don’t think that such risks could materialise. On the contrary, inflation expectations are remarkably well anchored in line with our definition—less than 2%, close to 2%.” Draghi talked a better talk, but kept denying the risk of persistent low inflation. In April 2014, he said that the ECB would be more aggressive only if inflation was low “for too prolonged a period.” In November 2014, his mantra was that more stimulus would be used only “if needed.”
The ECB finally followed the Fed with its own securities purchase program in January 2015. But delays and half measures have been costly. Greece and Spain are already in deflationary territory, and Italy is ready to fall into the same trap. Because deflation reduces nominal income while leaving debts untouched, it will make these countries’ debt burdens much harder to bear. Worse, the added austerity required to repay the debt will slow their economies and reinforce deflation.
Preemptive economic policy — one that acts before risks unfold — requires sound judgment and institutional capability. Facing an economic catastrophe, the Fed improvised and adapted. In the euro area, with its conflicting national interests and unwieldy decision-making mechanisms, the authorities have agreed on an economic philosophy that justifies no action until they have stepped into a morass.
The great risk is that eight years into the crisis, the Europeans have learned no lessons in macroeconomic risk management, and will remain behind the curve. Jens Weidmann, President of the Bundesbank and member of the ECB’s Governing Council, has complained that interest rates are too low. Schaeuble recently described low interest rates as an addiction, and his chief economist has the same dim view of fiscal stimulus. Meanwhile, the malaise is spreading. As China swoons, so will Germany and an ill-prepared euro area.
At its policy-making meeting in September, the Fed’s decision to not raise the policy rate was once again a pre-emptive step, this time to protect a relatively healthy domestic economy against looming global risks. Euro area authorities, dealing with more acute fragilities and more dependent on global economic health, should be seriously worried about these risks.
At its policy-making meeting this week, the ECB has another chance to lead rather than follow by expanding its bond-buying program. If it fails, we’ll know who really is clueless.
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