Jump­start­ing Europe’s econ­omy

Financial Mirror (Cyprus) - - FRONT PAGE -

Not so long ago, the no­tion of the Euro­pean Cen­tral Bank hand­ing out money to gov­ern­ments or di­rectly to cit­i­zens – so-called “heli­copter money” drops – would have seemed out­landish. But to­day a sur­pris­ing num­ber of main­stream econ­o­mists and cen­trist politi­cians are en­dors­ing the idea of mon­e­tary fi­nanc­ing of stim­u­lus mea­sures in dif­fer­ent forms.

This rep­re­sents a much-needed change in the con­ver­sa­tion – one that, at long last, fi­nally puts the fo­cus squarely on stim­u­lat­ing the de­mand side of the Euro­pean econ­omy. After years of stag­nant growth and de­bil­i­tat­ing un­em­ploy­ment, all op­tions, no mat­ter how un­con­ven­tional, should be on the ta­ble.

The United King­dom’s ref­er­en­dum de­ci­sion to leave the Euro­pean Union only strength­ens the case for more stim­u­lus and un­con­ven­tional mea­sures in Europe. If a large ma­jor­ity of EU cit­i­zens is to sup­port con­tin­ued po­lit­i­cal in­te­gra­tion, strong eco­nomic growth is crit­i­cal.

As re­search by McKin­sey Global In­sti­tute (MGI) shows, de­spite bold quan­ti­ta­tive eas­ing and record low in­ter­est rates – the ECB was the first ma­jor cen­tral bank to in­tro­duce neg­a­tive in­ter­est rates in 2014 – ane­mic de­mand con­tin­ues to hob­ble GDP growth through­out Europe. In sev­eral EU coun­tries, more than a quar­ter of the pop­u­la­tion has been un­em­ployed for close to a decade, and po­lit­i­cal dis­con­tent is boil­ing over into ex­trem­ism. The un­cer­tainty and volatil­ity in fi­nan­cial mar­kets in the af­ter­math of the Brexit vote will fur­ther crip­ple de­mand.

The wave of cor­po­rate in­vest­ment that was sup­posed to be un­leashed by a com­bi­na­tion of fis­cal res­traint (to rein in gov­ern­ment debt) and mon­e­tary eas­ing (to gen­er­ate ul­tralow in­ter­est rates) has never ma­te­ri­alised. In­stead, Euro­pean com­pa­nies slashed an­nual in­vest­ment by more than EUR 100 bil­lion ($113 bil­lion) a year from 2008 to 2015, and have stock­piled some EUR 700 bil­lion of cash on their bal­ance sheets.

This is not sur­pris­ing – busi­nesses in­vest when they are con­fi­dent about fu­ture de­mand and out­put growth. Even be­fore the Brexit vote, Euro­pean and other global com­pa­nies were not con­fi­dent in Europe’s prospects. Now they are con­fronting el­e­vated risks of a Euro­pean re­ces­sion and the real pos­si­bil­ity that both the UK and the EU could break up if pop­ulist con­ta­gion takes hold. Busi­ness in­vestors hate un­cer­tainty and the Brexit vote has cre­ated a dra­mat­i­cally more un­cer­tain world in Europe and be­yond.

Fis­cal aus­ter­ity and ul­tra-low in­ter­est rates have also proven in­ef­fec­tive at stim­u­lat­ing house­hold de­mand – and they may be back­fir­ing. When in­di­vid­u­als can­not find de­cent yields, they may ac­tu­ally in­crease their sav­ings to achieve their re­tire­ment goals. And in the typ­i­cal Euro­pean city, where land and af­ford­able hous­ing are in short sup­ply, lower in­ter­est rates have been driv­ing prop­erty prices higher rather than stim­u­lat­ing con­struc­tion.

It’s well past time to ac­knowl­edge the lim­its of cur­rent pol­icy. Un­der to­day’s pre­car­i­ous con­di­tions, de­mand could cer­tainly be bet­ter sup­ported through strate­gies other than quan­ti­ta­tive eas­ing and ul­tra-low in­ter­est rates. More­over, al­ter­na­tive ap­proaches to stim­u­late pri­vate de­mand might have fewer un­de­sir­able dis­tri­bu­tional con­se­quences, as MGI has dis­cussed.

Pro­po­nents of heli­copter money – di­rectly cred­it­ing cit­i­zens with cen­tral bank funds, or cred­it­ing na­tional trea­suries to fi­nance in­fra­struc­ture and other de­mand­gen­er­at­ing ac­tiv­i­ties – rightly ar­gue that it has the ad­van­tage of putting money di­rectly into the hands of those who will spend it. An ap­pro­pri­ately sized heli­copter-money pro­gramme might also raise in­fla­tion in a mea­sured way, head­ing off the pos­si­bil­ity of a Ja­panese-style de­fla­tion­ary trap. In­deed, the boost to de­mand might give cen­tral banks the open­ing they need to move in­ter­est rates back to­ward his­tor­i­cal norms. This could take the air out of in­cip­i­ent as­sets bub­bles that might be form­ing and ease pres­sures on in­sti­tu­tional in­vestors who are strug­gling to find the yield they need to meet their in­sur­ance and pen­sion com­mit­ments.

But a heli­copter-money pro­gramme – a fan­ci­ful idea when Mil­ton Fried­man pro­posed it in 1969 – would also be a rad­i­cal de­par­ture for pol­i­cy­mak­ers, re­quir­ing an abun­dance of cau­tion about cit­i­zen and in­vestor per­cep­tion, con­fi­dence, and solid gover­nance struc­tures. And such an ap­proach would ce­ment the no­tion that cen­tral bank pol­icy is “the only game in town,” re­liev­ing elected gov­ern­ment lead­ers of their re­spon­si­bil­ity for pro-growth poli­cies and the fis­cal de­ci­sions they con­trol.

A less risky and time-tested route for stim­u­lat­ing de­mand would be a sig­nif­i­cant in­crease in pub­lic in­fra­struc­ture in­vest­ment funded by gov­ern­ment debt. It is well doc­u­mented that Europe and the United States have un­der­in­vested in in­fra­struc­ture. From a macroe­co­nomic per­spec­tive, in­fra­struc­ture in­vest­ment is a “twofer”– it strength­ens pro­duc­tiv­ity and com­pet­i­tive­ness in the long run and, where there is un­used ca­pac­ity, it boosts de­mand, out­put, and em­ploy­ment with sig­nif­i­cant mul­ti­plier ef­fects in the short run.

Yet gov­ern­ments across Europe have clamped down on in­fra­struc­ture spend­ing for years, giv­ing prece­dence to fis­cal aus­ter­ity and debt re­duc­tion in the mis­guided be­lief that gov­ern­ment bor­row­ing crowds out pri­vate in­vest­ment and re­duces growth. But the crowd­ing-out logic ap­plies only to con­di­tions of full em­ploy­ment, con­di­tions that clearly do not ex­ist in most of Europe to­day.

In ad­di­tion, in­fra­struc­ture in­vest­ment can­not be de­ferred for­ever. A new reck­on­ing is war­ranted, one that ac­counts for the full costs of un­der­in­vest­ment in terms of fore­gone em­ploy­ment and growth.

One way to break the stale­mate is a change in pub­lic ac­count­ing stan­dards. Specif­i­cally, if gov­ern­ments were able to treat in­fra­struc­ture in­vest­ment just as com­pa­nies treat cap­i­tal ex­pen­di­ture – as bal­ance-sheet as­sets that are de­pre­ci­ated over their life­cy­cle, rather than as one-off ex­penses – such in­vest­ment could then be ex­empted from Europe’s deficit rules with­out open­ing the door to prof­li­gate spend­ing or eas­ing the pres­sure for cred­i­ble plans for longterm fis­cal-con­sol­i­da­tion. Of course, it would be cru­cial to im­prove the plan­ning and over­sight of in­fra­struc­ture projects si­mul­ta­ne­ously, as MGI has ar­gued.

Fresh think­ing about struc­tural re­form is needed, too. For decades, re­form dis­cus­sions in the EU have fo­cused on re­duc­ing la­bor-mar­ket reg­u­la­tion, cut­ting red tape in prod­uct mar­kets, pri­vatis­ing state-owned en­ter­prises, and low­er­ing tax rates. But re­form should now work with the grain of ef­forts to bol­ster de­mand – for ex­am­ple, un­leash­ing the sil­ver econ­omy, fos­ter­ing dig­i­tal ed­u­ca­tion and in­no­va­tion, and un­lock­ing ur­ban land mar­kets to pave the way for much­needed in­vest­ment in hous­ing.

Each of these op­tions would re­quire ro­bust de­bate and deeper in­ves­ti­ga­tion. But it’s clear that Europe needs a larger set of pol­icy op­tions. Quan­ti­ta­tive eas­ing and ul­tra-low in­ter­est rates should no longer be the only ar­rows in the macroe­co­nomic pol­icy quiver. These tools, along with ex­ces­sive fis­cal aus­ter­ity, may have higher costs in terms of fore­gone em­ploy­ment and growth – and ris­ing po­lit­i­cal dis­con­tent – than “risky” al­ter­na­tive op­tions. The Brexit vote is a ca­nary in the coal mine for Europe’s eco­nomic pol­icy mak­ers. Un­con­ven­tional times re­quire con­sid­er­a­tion of bold un­con­ven­tional pol­icy ap­proaches.

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