Draghi can’t fix eurozone alone
European Central Bank cuts rates, but Germany must ease its fiscal policy to boost recovery
FOR the second time in 15 months, Mario Draghi has shown his willingness to do “whatever it takes” to foster a recovery in the eurozone.
Echoing the spirit that led him to unveil his unlimited bondbuying programme last summer, the European Central Bank president has now cut interest rates to 0.25%, a record low.
Investors who thought the bank would need a longer period of reflection before acting were caught on the hop.
Stocks jumped and the euro fell to a seven-week low. But the further monetary loosening is hardly premature.
For all the talk of recovery in recent months, economic activity in the eurozone has been weak and unemployment, particularly in crisis-hit countries, stubbornly high.
If anything, the central bank should have acted sooner.
However, German political opposition to a new monetary stimulus has been formidable. Jens Weidmann, president of the Bundesbank, voted against Thursday’s rate cut.
Draghi was right to face down the Bundesbank on this occasion. A rate cut is consistent
Brussels has made too little progress in addressing the real curse of the eurozone — its large and persistent current account imbalances
with his bank’s mandate, which states that it should keep inflation at 2% or marginally lower. In October, prices rose by a mere 0.7%.
The eurozone has entered a period of disinflation. This is worrying. Consumers and businesses have fewer reasons to spend their cash today if they know that prices tomorrow will not be much higher. Some in- flation is also a relatively costless way of shrinking public debts.
One should be cautious, however, about what a rate cut can achieve.
The monetary plumbing of the eurozone remains clogged as banks in countries such as Spain and Italy refuse to pass the central bank’s ultra-cheap rates on to consumers.
Demand for new loans is also weak as companies in crisis-hit countries continue to experience sluggish domestic demand.
The bank should be ready to go further than it has this week. The question is what tools would be most effective.
One option would be to set a negative interest rate on the money that lenders park with the central bank. This would act as a tax on reserves and might encourage some banks to lend more. The central bank is right to contemplate such an unprecedented step.
Another useful move would be to launch a new round of cheap loans to eurozone banks at a fixed, ultra-low rate — even though this may cause some problems. The concern is that lenders may use the funds simply to purchase government bonds, something that Spanish and Italian banks have done in the past.
The central bank should therefore think about ways of tying the extra funding to a requirement for banks to expand their loan books. This would put cheap money directly into the pockets of those who need it.
However, the best way to repair the eurozone’s monetary transmission mechanism would be to ensure that the banks are properly capitalised so that they are in a position to extend new loans.
This is why the central bank’s forthcoming audit of the euro- zone banking system is so important.
Governments must give Frankfurt the political cover it needs to do its job. Although markets should be the first stop for any capital injection, eurozone funds may be needed as a backstop. Politicians and eurozone institutions cannot expect the European Central Bank magically to revitalise the currency union on its own.
The European Commission has seen sense in softening its obsession with unreachable deficit targets. But Brussels has made too little progress in addressing the real curse of the eurozone — its large and persistent current account imbalances.
The onus should be on Germany to relax fiscal policy or let wages rise faster.
Sadly, such internal rebalancing remains politically implausible. But it would do a lot more than Thursday’s rate cut. — © The Financial Times