What if Europe slides into recession?

WASHINGTON >> While almost everyone in Washington is glued to impeachment developments, Europe has been quietly drifting toward a recession. This is bad news for Christine Lagarde, the former head of the International Monetary Fund, who is now the president of the European Central Bank (ECB). It may also be bad news for the rest of us.

By the usual indicators — which define a recession as two consecutive quarters of a shrinking economy — Europe is almost there. Growth of the euro-zone’s gross domestic product (GDP) was a meager 0.2 percent in the third quarter. Growth for Germany, Europe’s largest economy, was only 0.1 percent. Employment growth for the eurozone, the 19 countries using the euro, was only 0.1 percent.

No one can want this. The economics are brutal: higher unemployment, lower confidence and squeezed profits. The politics are worse: greater distrust of government, more nationalism (including more suspicion of immigrants) and rising alienation.

But what can be done, if anything?

Note that the ECB is Europe’s equivalent of the Federal Reserve. The tenure of Lagarde’s predecessor, Mario Draghi, who ran the ECB from November 2011 until last month, is widely considered a success, because his policies prevented the euro from being abandoned by weaker countries (for example, Greece or Portugal). Their exit from the eurozone might have shattered the whole scheme.

This was always a plausible threat if euro-denominated debts could not be repaid. The crisis might also have been selffulfilling. If depositors expected that, say, Spain might leave the euro, the fear might trigger a panicky outflow of money from Spanish banks.

On July 26, 2012, Draghi effectively foreclosed these possibilities by declaring that the ECB would do “whatever it takes” to avoid the euro’s collapse, adding that “believe me, it will be enough.” In effect, Draghi pledged that the ECB would lend enough to banks and financial markets to ensure that they could meet their euro obligations.

Later the ECB reduced shortterm interest rates and embraced its version of “quantitative easing” (QE). This was an approach adopted by the Fed under Chairman Ben Bernanke. It involves having the central bank — the ECB or the Fed — buy bonds to reduce long-term interest rates.

Both the United States and Europe are in similar economic positions. In each, recovery is faltering. The basic problem on both sides of the Atlantic is that economies have become dependent on governmentcreated “stimulus” policies — whether low interest rates supplied by central banks or huge budget deficits created by politicians — rather than being able to generate spontaneous internal growth.

The trouble with this approach is that the governmentsupplied stimulus programs are losing their punch. In both America and Europe, low interest rates are proving less and less effective in expanding GDP and employment. Whatever the initial effect of low interest rates and the QE programs of bondbuying, the law of diminishing returns seems to have set in. The benefits seem to be fading.

This creates a dilemma for the ECB and Lagarde. In a short report, Jean Pisani-Ferry of the Peterson Institute for International Economics notes: “Growth in the euro area has slowed since the beginning of 2018, and the risk of a recession is growing.”