ECB: Euro area should smooth out the consumption and income shocks of its members

Vítor Constâncio, Vice-President of European Central Bank. (EU Parliament Audiovisual Services).

Vítor Constâncio, Vice-President of European Central Bank. (EU Parliament Audiovisual Services).

Last Tuesday Brussels celebrated the return of the Eurozone inflation to positive grounds after five straight months of deflation (negative inflation). Some EU Commission economists, among others, assume that three positive decimal points of change of the level of consumer prices in May (0.3%), can signal the return of the economy to growth. Under an orthodox interpretation of the prevailing economic theory this may be correct. Yet on the same day when Eurostat released its flash estimate for the May inflation rate, it also published data on industrial producer prices in euro area finding that they are still stuck in the negative part of the chart (-0,1%).

In any case, the fact that the headline inflation has crossed to the positive part of the graph is in itself an encouraging indication that Eurozone for the time being is escaping from the deflation region. But can it be taken as proof that the euro area has definitely entered a solid growth path? Obviously the answer is no. If the opposite was true the European Central Bank would have second thoughts about continuing its money printing and distributing program.

The ECB currently spends at least €60 billion every month of freshly circulated euros. All central Bank dignitaries who have commented on this program have repeatedly stressed that the ECB will continue this project for as long as it is needed. That is, for as long as the Eurozone needs a monetary bonanza to regain a growth path. It is certain then that an increase of the consumer price level by few positive decimal points of a percentage unit may not signify an irreversible passage to safe grounds.

Who is the pessimist?

However, even if all those are thoughts of a pessimistic mind, nobody can deny the fact that a number of Eurozone countries have lost smaller or much larger chunks of their Gross Domestic Product during the 2009-2013 crisis. They still haven’t recovered those losses. In short, the optimistic thinking that Eurozone is leaving a five year crisis period behind doesn’t tell the whole truth. The reason is that at least five countries, namely Greece, Italy, Ireland, Spain and Portugal still haven’t recuperated the GDP losses they suffered. It may be true that all of them even Greece have again returned to the positive part of the growth graph, but the recovery is quite precarious. This last observation is true even for France and other euro area economies like Finland, Holland, Cyprus, Slovakia and Slovenia.

That’s most probably why the ECB says it will continue and rather strengthen its €1.14 trillion money printing program, which last March started disseminating at least €60bn a month and will run until September 2016 or for as long as it is needed. Last Saturday though, Vítor Constâncio, Vice-President of ECB went much further than that. Speaking at the XXXI Reunión Círculo de Economía, in Barcelona on 30 May, he said that the Eurozone doesn’t support effectively its unlucky member states as other single money areas do.

What a single money area should do?

Constâncio said more or less that Eurozone abandoned its crisis hit member states at the time of need. He stressed that “Risk-sharing among euro area member states seems to have increased after the introduction of the euro. Available estimates suggest that in 2008-2009, 57% of shocks to state gross product per capita were smoothed. However, in 2010 risk-sharing declined significantly in most EU countries and essentially collapsed in countries under fiscal stress”. The ECB Vice President compared that with the US by saying “The U.S. have traditionally been characterised by a very high degree of income and consumption smoothing across states that has only been increasing over time. The available evidence suggests that about 75% of income shocks in individual states are smoothed”.

The comparison made here is crying out. Of course Constâncio as a central banker cannot draw the obvious political conclusions. Evidently, a money zone must apply political guarantees to its member states that the mutual support between them should increase with time and not collapse when the crisis comes. Unfortunately, the latter occurred in the euro area during the past years. When some member states started to stutter in 2009 their partners only offered them loans. No substantial “income and consumption smoothing across states” took place. An impartial observer would add that the loans offered (to Greece, Ireland, Portugal, Cyprus and Spain) were used to save the banks of the lender countries (Germany and France). In this way Athens, Dublin, Lisbon and Madrid undertook 100% of the burden to save the German and French bankers.

Constâncio says it loudly

In view of that, Constâncio said that “ECB policies are working and making a significant contribution to the normalisation of economic conditions in the short-term. Let me add that they also help the medium-term as, by closing the negative output gap, they reduce the detrimental of effect of hysteresis on the labour supply and the capital stock”. Acknowledging, though, that monetary tools cannot substitute economic policies he said “This (productivity increase) will not be achieved without a continued effort to implement structural reforms for which monetary policy is not responsible”. In reality at this stage he swiftly passes the ball to the politicians’ court.

Let’s now draw the obvious political conclusion that Constâncio as a central banker couldn’t, at least not loudly. Of course the subject matter of this issue is the effectiveness of political cooperation and the quality of the financial bonds between the member states of a money zone. A single money area that doesn’t smooth out the consumption and income shocks of its member states cannot be long-lived. As a matter of fact, Eurozone will start unraveling now, if Greece will be its first member to abandon it.


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