Eurozone in dire need of a radical makeover
This is a dangerous way to run economic policy, but I suppose if one has been kicked around for so long then any opportunity to flex some muscle will be grabbed with both hands.
Only time will tell if it is the correct decision or not, but the risks are pretty obvious. If one believes the eurozone debt crisis has been confined to the annals of history, then fine, but recent data releases clearly show just how fragile the new-found sense of optimism in relation to the status of the region really is.
While the area emerged from recession in the second quarter of the year, the recovery slowed drastically during the third quarter, with growth of a paltry 0.1% recorded. Activity was still 0.4% down on the same period last year.
During the third quarter, Germany expanded by just 0.3% and was just 0.6% higher than a year ago; the Netherlands expanded by 0.1%, but France and Italy both contracted by 0.1%.
These numbers are not indicative of a region characterised by any tint of vibrancy. Therein lies the risk for Ireland.
In advance of these pretty dreadful growth numbers, it is little wonder the ECB took the panicky decision to cut official interest rates to just 0.25% a few weeks ago. There is a major growth disease at the heart of the eurozone project at the moment and it is becoming clearer by the day that the conservative approach traditionally adopted by ECB policymakers is totally inappropriate to the current economic circumstances.
The fact is that 19.4m people are out of work in the eurozone; growth is pretty much non-existent; and the inflation rate at just 0.7% is well below the desired target of 2%. Clearly, deflation is a much bigger threat than inflation.
It is not clear what further range of weapons from the existing armoury can be used to address this situation. The ECB could take its official rate down to zero, as is the case in Japan and the US. But taking rates down to such levels is like trying to push on a piece of string. Try it if you don’t believe me.
A radical approach to growth is required. Horror of horrors, the ECB may have to contemplate utilising the approach used in the UK and more aggressively in the US; namely quantitative easing or the printing of new money.
This would in many ways be a desperate measure, but desperate times do require desperate responses. The fear is that the ECB, with the backing of the Germans, will refuse point blank to pursue such a course of action and the eurozone economy would remain in the doldrums.
It is possible that the eurozone could flatline for the foreseeable future and eventually muddle through. However, such a scenario would just compound the unemployment crisis and raise sovereign debt burdens in some countries to a level that might freak out the markets again. That is precisely what happened in Ireland, Greece, and Portugal over the past three years.
The safest option would be for eurozone policymakers to throw caution to the wind and pursue a much more aggressive pro-growth strategy. For the peripheral economies, that would be manna from heaven, but for a country like Ireland that is learning to stand again, it is an absolute imperative.
If European policy does not change, Ireland might just find itself in a very exposed situation at some point over the next couple of years, but if Mario Draghi’s new year resolution is to go for broke, then the future could be a lot better. All eyes need to remain focused firmly on Frankfurt.
