South Eurozone needs some…inflation and liquidity

Discussion between Angela Merkel, German Federal Chancellor, on the right, and José Manuel Barroso, President of the EC. (EC Audiovisual Services).

As it was expected, Eurostat proved to be right in its last week’s estimate that February yearly inflation was less than 2% on the average in the 17 member states Eurozone. As a matter of fact yesterday’s announcement of the EU’s statistical service revealed that February inflation was 1.8%. Inflation rates diverged wildly between the 17 economies, from 0.1% in Greece and 0.2% in Portugal to 3.2% in Holland.

If each one of those countries had its own central bank, as is was the case until 2001, monetary policies would have varied largely to accommodate the needs of their real economies. Very simply in countries with low or non-existent inflation pressures and largely negative growth like Greece and Portugal, central bank’s monetary policy would have aimed at reviving the real economy. In this case the usual policy tools would have been lower interest rates and cheap liquidity injections, to help the economy attain a growth path. Some more inflation could have appeared as a side effect.

Monetary policy for whom?

In today’s reality though the one and only Eurozone central bank, the ECB, does nothing of the kind. It acts as if the European South does not exist. To be fair one must accept that central banks should not be responsible for growth policies. This is the governments’ responsibility.

However, all over the world from Japan to the US and from Swiss to Australia, central banks are cooperating closely with governments to help the real economy grow and create jobs. Unfortunately this is not the case with the ECB. Eurozone’s central bank is limiting itself in supporting only the financial sector, as if the real economy belongs to another planet. Under this logic the ECB says it is occupied only with monetary policy.

In any case ECB’s leadership cannot avoid recognising that its monetary policy is not transmitted effectively to all member states. Central bank’s governor, Mario Draghi said that last week. Of course this is only a tiny part of the truth. The reality is that almost half of Eurozone does not have any monetary policy at all and in many countries liquid money is becoming everyday all more scarce.

incidentally it must be noted that the ECB has a built-in inability, to directly lend money to governments in order to help them revive the real economy. In reality this is not an insurmountable problem and has on many occasions been sidestepped.

Liquidity only for some

For example Draghi introduced last year the Long Term Refinancing Operations, under which the ECB lent more than one trillion to banks, of which large amounts went to governments, through the local bond markets. This was far from being enough. Actually it helped only the banks to make some easy billions. All four south Eurozone countries are still left without liquidity, with the problem actually growing not receding. This situation is very poorly described with the phrase, “the monetary policy doesn’t go through to all”. But there is more.

Last week Draghi said, “The annual growth rate of loans to non-financial corporations stood at -1.5% in January, after -1.3% in December 2012… To a large extent, subdued loan dynamics reflect the current stage of the business cycle …In order to ensure adequate transmission of monetary policy to the financing conditions in euro area countries, it is essential to continue reducing fragmentation of euro area credit”. All that may have some meaning, if you are based in Frankfurt. In the Mediterranean they mean nothing to nobody.

Draghi couldn’t avoid recognising that on the average, bank loans in Eurozone are decreasing. What he avoided to accept was that if they are decreasing on the average, in the South of Europe new loans to businesses and households are  becoming rarer than whiteflies. With no available credits the real economy is doomed. In the above quote Draghi accepts also that there is no transmission of the monetary policy to all the Eurozone countries. He doesn’t say though that in the south borrowing is not only unavailable, but it costs many times more than in the North. Consequently it’s not unfair to say that the existence of the ECB, creates insurmountable disadvantages for the Mediterranean countries.

Adding up all that, one arrives at the conclusion that the South of Europe being deep in recession and suffering of unseen before unemployment rates is driven surely to a trap of disinflation and recession. This terrifying prospect cannot be reversed with the cost of credit rendering almost every investment plan as non-viable.

If those countries had their own central banks, as it was the case some years ago, everything would have been different. With adequate injections of cheap liquidity the real economy would have resumed its pre-crisis activities, unemployment would have been much lower and inflation probably higher than presently. A small devaluation of drachma, lira, peseta and escudo would have probably helped restore the competitiveness of the local economy. In a few months all four economies could have started growing again. Unfortunately today they run the utmost danger of complete economic, social and political disintegration.

All in all Greece, Italy, Spain and Portugal are suffering their worst crisis after WW II. Then who can blame Beppe Grillo, when he said that Italy is practically out of Eurozone?