Eurozone set to abandon monetary and incomes austerity and adopt growth friendly policies

European Parliament. Committee on Economic and Monetary Affairs meeting. Monetary dialogue with Mario Draghi, President of the European Central Bank (seated). MEP Peter van Dalen (ECR, NL) greets the central banker to Parliament. (EP Audiovisual Service 16/12/2013).

European Parliament. Committee on Economic and Monetary Affairs meeting. Monetary dialogue with Mario Draghi, President of the European Central Bank (seated). MEP Peter van Dalen (ECR, NL) greets the central banker to Parliament. (EP Audiovisual Service 16/12/2013).

Finally, the European Central Bank’s Governing Council unanimously agreed yesterday to use extraordinary monetary measures to support growth in Eurozone and to counter a possible further fall of inflation rate towards the negative deflation region. To this effect, the ECB stopped just one step short from taking unconventional monetary measures, but the fact that its President Mario Draghi stated that the central bank is ready to do so, is tantamount to the real action. In short, ECB’s Governing Council in its regular monthly meeting yesterday unanimously acknowledged the precarious state of Eurozone’s economy.

Growth by printing money

This means that yesterday even the two German members of the Council endorsed the possibility that the ECB might need to support real growth with monetary measures, a possibility strongly denied by Berlin so far. The German government has been maintaining that growth cannot be based on monetary ‘quantitative easing’. The truth is though that all the major central banks of the developed world (the American Fed, Bank of England, Bank of Japan) have flooded their economies with plenty and cheap freshly printed money (quantitative easing), in order to support growth in the real economy. The ECB had so for denied to apply the same recipe.

This seems to be changing now. ECB’s Governing Council unanimously accepted that it may adopt quantitative easing, if low inflation and real economy stagnation persist. On top of that, Draghi confirmed that the key ECB interest rate (now at 0.25%) will remain at its present or lower levels for an extended period of time. This is the well known new ECB strategy to keep the markets informed in advance, about its future policy intentions (forward guidance).

Hard realities

The confirmation that the ECB may further reduce its interest rates and also that it may adopt further quantitative easing are indirect acknowledgments that inflation is expected to remain subdued, well into the foreseeable future. Draghi said that “Over the following months, annual Harmonised Index of Consumer Prices (HICP) inflation is expected to remain low, before gradually increasing during 2015 to reach levels closer to 2% towards the end of 2016”.

In short, only after two years the inflation rate may reach the levels set as appropriate by the ECB itself. The usual statement by all ECB dignitaries is that ‘inflation rates should remain below, but close to 2%’. At the beginning of this week Eurostat, the ECB statistical service, estimated March inflation at 0.5%, the lowest level since the crisis period 2009-2010. During the past few months, since October 2013, the rate of change of HICP is falling fast and posing the threat of deflation. At this point it must be noted that in negative inflation all assets in the economy, nominal and real, may lose large parts of their value, a process which may lead to a real economy crisis and even trigger an economic crash. It becomes obvious that the falling inflation rate constitutes a great threat for Eurozone.

Confronting threats

However, subdued inflation is not the only problem that the ECB sees as a threat. Together with falling inflation, euro area economy seems to stagnate just above zero. Yesterday in his introductory statement, Draghi said that “Real GDP in the euro area rose by 0.2%, quarter on quarter, in the last quarter of 2013, after 0.1% and 0.3% in the previous two quarters respectively. Survey data that encompass the first quarter of this year are consistent with continued moderate growth…” This is a straight forward admission that the ECB has very good reasons to believe that growth will remain quite anemic also in 2014.

It appears that in total, the overall picture for Eurozone is not at all rosy. According to Draghi, “The risks surrounding the economic outlook for the euro area continue to be on the downside. Developments in global financial markets and in emerging market economies, as well as geopolitical risks, may have the potential to affect economic conditions negatively. Other downside risks include weaker than expected domestic demand and insufficient implementation of structural reforms in euro area countries, as well as weaker export growth”.

All those negative prospects threatening Eurozone are not new though. Many important economic institutions like the IMF have been ringing the bell for months, seeing stagnation and disinflation in Europe. Now it seems that the EU decision makers in Berlin, Paris, Brussels and Frankfurt, where the ECB is seated, have been finally convinced that there has to be a change of course in Eurozone’s economy, from austerity to relaxation. The historic adoption by the German government of a legal minimum wage at €8.5 on Wednesday and the concession that the ECB may flood Eurozone with more and cheap money, are two infallible witnesses that something is about to change in Europe. It was high time.

As they say better late than never, with Germany about to undertake the role of a real economic leader of Eurozone, accepting policies which will take care of the needs of all member states. Understandably, Berlin is to stop protecting only its own interests, as it was the case since yesterday.

 

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