The European Central Bank president delivered a ground-breaking
speech at Jackson Hole, calling for government spending to do more
of the heavy lifting of bringing idled workers back on the job while
acknowledging that, his previous excuses aside, market prices show
he is losing the battle against falling inflation.
All of this is refreshing, and would be highly encouraging but for
some pesky realities.
Euro zone countries are not likely, any time soon, to engage in any
meaningful stimulus through government spending.
And monetary policy faces pretty severe mathematical, structural and
cultural constraints. Zero is a barrier that is pretty hard to get
below, and quantitative-easing-style maneuvers face their own
issues. Not only is there only a small market for asset-backed
bonds, which the ECB is likely to eventually start buying up, but
there is a taboo, made flesh in law, on the central bank providing
direct financing to member governments.
One thing Draghi did achieve, and should be able to sustain, was
weakening the euro, which fell to near one-year lows against the
dollar. Currency trading being a game about relative strength,
Draghi’s comments, even if not backed with as much action as they
would seem to warrant, show that policy will be more accommodative
in the euro zone than in the U.S.
Draghi is both blessed and cursed by being perhaps the only major
figure in the euro zone drama who can act both quickly and with some
force. That was clearly shown with his electrifying “whatever it
takes” comments in 2012, when he more or less single-handedly
backstopped the euro project against disaster.
But though he has more scope for action than, say, French President
Francois Hollande, who is currently trying to reconstitute his
government, he faces very real limitations when we come round to
The market view, in the wake of the speech, was that this brings us
closer to outright QE in the euro zone. This is probably correct,
but possibly slightly beside the point.
A CABLE TO BERLIN AND ROME
Draghi is asking for help from the fiscal authorities because it is
obvious that help is needed, that the current mix of semi-austerity
and loose but constrained monetary policy is not sufficient. But the
problem with saying that is that it ultimately brings the focus back
to the peculiarities in European arrangements which helped to create
this state and which have not changed.
“Reading the fine print of the Stability and Growth Pact, and taking
account of political constraints, we do not expect to see any
significant shift in the region’s fiscal policy,” economist Michala
Marcussen of Societe Generale wrote in a note to clients.
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Under the Stability and Growth Pact, which governs fiscal policy by
euro zone countries, each is enjoined to keep structural budget
deficits at no more than half a percent of GDP and act to reduce
public debt to 60 percent of GDP over two decades. German Chancellor
Angela Merkel agreed over the summer that countries should have more
time to meet those targets, but only if their budget deficit is less
than 3 percent of GDP. Scanning the list of member states we find
that only Italy and Germany might qualify, and potentially be
candidates for expansionary spending.
Well, Italy is currently in a recession which is about to make a
mess of its budget, and Germany seems a politically unlikely
candidate for single-handedly spending the euro zone back to fuller
employment. Draghi did speak of a euro-wide budget for public works,
but again, this may never happen and certainly won’t before he’ll be
called upon to start buying up bonds.
This brings us back to the limitations on size and scope for
bond-buying operations in the euro zone, and in turn, to the
limitations on how much of an impact this might have.
In the U.S., where there is a large and deep mortgage bond market
and a single government bond issuer, QE has been helpful,
particularly in its earlier iterations, but hardly a sovereign cure
That brings us back to talking the euro down, something that may
well prove to be Draghi’s biggest success, both at Jackson Hole and
going forward. Monetary policy in Europe will likely soften more
than that of the U.S. and all of this points up structural reasons
for slow longer-term growth with more risk.
A weak euro will help, but may not be enough to get Europe out of
the deflation danger zone.
(At the time of publication James Saft did not own any direct
investments in securities mentioned in this article. He may be an
owner indirectly as an investor in a fund. You can email him at
firstname.lastname@example.org and find more columns at http://blogs.reuters.com/james-saft)
(Editing by James Dalgleish)
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