To avoid crisis, Germany must loosen purse strings

To avoid crisis, Germany must loosen purse strings

When I started working in the world of economics many moons ago, there was a cliched-term often used in popular discourse called ‘Eurosclerosis’. It was a term coined to describe and capture the anaemic growth that had characterised Europe for years.

The mantra from EU officials and indeed in ‘official Ireland’ in the run up to 1999 was that the creation of the Single European Currency and the completion of European Economic and Monetary Union (EMU) would solve the long-term economic problems in the countries participating in the great monetary experiment.

The argument went along the lines that the removal of exchange rate uncertainty, the control of interest rates by the European Central Bank (ECB) and the generally greater level of integration and co-operation that would ensue, would combine to create a level of economic dynamism that had been sadly lacking for decades.

This was never likely to be the case, and indeed that is how it has turned out. The creation of EMU was a project driven by political expediency and did not make a lot of economic sense, at least in the manner that the mechanism was set up.

We got a central bank that sets a single interest rate for a plethora of very different economies, but it was accompanied by a very low level of political and fiscal integration. Every member country tends to put the national interest first and the greater good of the monetary union is generally treated as a poor second.

There is no element of fiscal union and no acceptance that a form of fiscal federalism or fiscal-transfer system would be necessary to make the project work. However, there was and still is no political acceptance of fiscal transfers for the centre to help those countries experiencing asymmetric economic shocks – in other words shocks that are unique to a country.

There was also no acceptance of the need for a banking union, which would have seen a centralised response to a banking crisis, rather than a system of hanging out errant countries to dry, which was the painful experience of Ireland back in 2009 and thereafter.

History will show that the EMU project nearly collapsed in the years after 2010 and but for the commitment from the ECB President, Mario Draghi, that the ECB would stand ready to do whatever it took to save the system, it could very easily have imploded.

However, the Euro Zone emerged from the crisis on the back of Draghi’s commitment, which he delivered upon, and in the early months of 2018, the zone was displaying an amazingly strong and amazingly synchronised economic cycle.

At that stage, some of us forgot our belief systems and started to believe that perhaps the Euro Zone had turned a corner, and that by the end of 2019, the ECB might be tempted to start signalling an intent to eventually move away from the crisis-driven zero interest rate policy.

Alas, those beliefs have proven very ill-founded and over the past year, the Euro Zone economy has plunged back into sclerotic growth and there is no possibility of the ECB tightening monetary policy as far ahead as one can reasonably forecast.

In fact, the ECB now stands ready to start loosening monetary policy again, in an act of desperation.

The latest growth numbers for the Euro Zone show that in the second quarter, the Euro Zone economy delivered annual growth of just 1.1 per cent, with Germany clocking in at a mind-blowing 0.4 per cent and Italian activity literally stagnated.

Germany is now in distinct danger of moving back into technical recession and Italy looks set to become a major source of instability for the Euro Zone.

The problem is how to deal with this abysmal growth performance. With official interest rates at zero and many bond yields already in negative territory, there is probably a limit to what further monetary easing might achieve.

The only apparent solution is that Germany needs to loosen the purse strings and engage in a massive capital investment programme, that would give a short-term boost to Germany and hence to the rest of the Euro Zone. Failing that, it appears a high probability that the next Euro Zone crisis is just over the brow of the hill.

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