The ECB must extend its money stimulus beyond 2018: Draghi reckoning

Mario Draghi, President of the ECB (on the right), bits farewell to Vítor Constâncio, the Portuguese Vice-President of ECB, who is to be succeeded in Vice Presidency by the Spaniard Luis de Guindos. ECB Press conference of 26 April in Frankfurt am Main. (Photo, ECB work; some rights reserved).

Last Thursday, 26 April Mario Draghi, tactfully left it to be understood that Eurozone may not any more grow so fast as we all knew it was doing until recently, and, consequently, the inflation goal of close to 2% may not be achievable. He communicated that by not repeating what he had said on 8 March, when he had clearly stated, “This outlook for growth confirms our confidence that inflation will converge towards our inflation aim”. Last Thursday, instead of ‘confirms’, he said  “continues to support our confidence that inflation will converge towards our inflation aim”.

The intended differentiation between the fullest possible avowal of “confirms our confidence” and the rather optimistic meaning of “continues to support our confidence” was some minutes later further confirmed. He was speaking at the customary afternoon Press conference following the 26 April ECB‘s Governing Council meeting. Right after his initial statement, Draghi was asked by a journalist the following question: “…now that we’ve seen some weaker-than-expected data (about inflation), is there a risk that the variance in inflation could increase and potentially slow down the process of convergence”?

Inflation moves sideways

Draghi responded yes in a clear cut way: “measures of underlying inflation since our last meeting moved sideways. There hasn’t been any convincing upward trend or signs that this upward trend is about to come.” He is adamant here, confirming that the inflation outlook and the wider economic conjuncture have changed and “ there hasn’t been any convincing upward trend or signs that this upward trend is about to come”.

The truth is that the change in Eurozone’s economic prospects has been noticed by all the major analysts since a few weeks ago. They point to the risks to growth from the American trade protectionism and the rise of the euro/dollar parity, impeding the exports of euro area and making imported goods cheaper. All that undermines growth and results in further depressing the already low inflation rate (1.3% in March).

The French were fast to notice – policy wise – what the contrast between the recent change of economic circumstances and the December decision of the European Central Bank signify. To be reminded, at the end of last year, the Governing Council of the central bank had decided to stop its extraordinarily accommodative measures (quantitative easing). However, abandoning this monetary stimulus to growth now, as the Germans persistently demand, will mean a lot of problems for many Eurozone countries including France. So ‘la Banque de France’ reacted swiftly.

The French insist

Francois Villeroy de Galhau, the Governor of the Bank of France stated last week that the European Central Bank shouldn’t bring to an end its extraordinary monetary measures in September, because “growing risks from protectionism, exchange rates or market swings end up depressing inflation”. On principle, the basic mandate of ECB is to bring inflation close but below 2%.

To that end, during the past many years the central bank has printed and circulated €2.5 trillion of new money and kept its basic interest rate at flat zero, thus reviving inflation and at the same time helping growth.  Stopping this monetary stimulus to economic activity and ending the endeavor to revive inflation at this point in time is then a flagrant violation of ECB’s mandate.

Last December, ECB’s Governing Council on the insistence of Germany and her few Eurozone followers, decided to stop this accommodative policy, since they considered that the euro area economy was already growing fast enough, so the inflation target was reasonably expected to be achieved thereafter. Now, the French, and practically everybody else, say the conjuncture has changed once more and the extraordinary measures are still needed.

Berlin thinks otherwise

To be noted, all along the past years, Berlin has been strongly opposing this extraordinary policy of quantitative easing and the zeroing of interest rates, being the only European country with gigantic reserves. Everybody else in the euro area needed those unorthodox measures in order to refinance their debts at a lower interest cost and leave some space for government spending to support growth. The Eurozone badly needed to recover from the 2008-2010 financial Armageddon. Today the recovery is again uncertain.

Last week, then, de Galhau observed that the Eurozone must now face the new challenges which are bound to suppress growth and inflation again. So, the ECB must continue with its extraordinary measures well beyond 2018 and change its December decision for stricter policies. Obviously, this option is opposed by Germany. Berlin has all along the past years opposed what everybody else needed, despite the fact that the German economy has thrived on exports to the rest of the euro area, and could expect more gains from other people’s better prospects.

What Eurozone needs

There is, then, an evident and disturbing discrepancy between what the German decision makers think about their obligations towards the rest of the Eurozone, and what everybody else expects. Recycling the huge trade surpluses Germany has accumulated from the rest of Eurozone, through investments and more consumption, has been the obvious solution to the woes of the rest of the euro area countries. On top of that, such a visionary policy would, in the long run, further support Germany’s successes. Only the Germans stubbornly refuse to see it. Neutralizing those surpluses by just stockpiling them is a hopeless growth cutter for the entire Eurozone.

During the coming few weeks, we will learn if Berlin is again to win the match game in Frankfurt am Main or if common sense is to prevail. The next meeting of ECB’s governing Council is scheduled for 1st June.