“But this long run is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is long past the ocean is flat again.”
–John Maynard Keynes, A Tract on Monetary Reform (1923)
Death is no longer at the Eurozone’s door. Since 2010 and the onset of the Greek debt crisis, the Eurozone has repeatedly proven its ability to muddle through seemingly existential crises. Contrary to the predictions of many astute economic observers, the euro as a currency has survived and the Eurozone as an economic and political unit has remained intact. Those who predicted impending doom underestimated the effectiveness of the European Central Bank’s (ECB) easy money policies, beginning when Mario Draghi took the helm of the institution in 2011, as well as the quiescence of democratic political regimes in the face of strident international creditors.
In 2012, the insolvency of Spain’s fourth largest bank (Bankia) roiled European bond markets and undermined confidence in the financial stability of European debtor nations such as Spain, Italy, Portugal, Ireland, and Greece. In direct contrast with his predecessors, Draghi gave a speech in which he declaimed the ECB would do “whatever it takes” to prevent the disintegration of the euro. With said speech, Mario Draghi effectively restored calm to European financial markets.
Later, in 2015, Greek voters tired of austerity measures dictated from Brussels and Berlin, overwhelmingly rejected a more severe austerity plan in a nationwide referendum. Greece’s government, experiencing bank runs and facing the potential for expulsion from the Eurozone, acceded to Brussels’s wishes and implemented the austerity plan regardless. In both instances, the Eurozone came frighteningly close to death but ultimately averted it.
Yet with high unemployment in Greece, Spain, Italy, and Portugal, below ECB target inflation across all of Europe, and low growth rates in France and Germany, economic sickness still pervades much of the continent. What measures might the Eurozone adopt in order to speed up its convalescence?
Before we try to cure the patient, we must accurately diagnose the disease. Most reputable economists agree that what ails the Eurozone, along with much of the industrialized world, is a persistent lack of aggregate demand. Corporations are sitting on trillions of dollars of reserves but are unwilling to invest it because consumers, still deleveraging from the debts they racked up in the run-up to the 2008 financial crisis, do not currently make sufficient money to buy those corporations’ products in significant enough numbers. Former U.S. Treasury Secretary Lawrence Summers has recently put in vogue a 1930s economic term describing the situation: secular stagnation.
Mr. Summers suggests that, under secular stagnation, “the economies of the industrial world…suffer from an imbalance resulting from an increasing propensity to save and a decreasing propensity to invest. The result is that excessive saving acts as a drag on demand, reducing growth and inflation, and the imbalance between savings and investment pulls down real interest rates.” The starkest example of this is Japan, where economic growth has slowed to a crawl for the past two decades despite repeated interventions by the Bank of Japan, the central bank, to make credit more available to financial institutions, businesses, and consumers. The threat of deflation still looms.
“Before we try to cure the patient, we must accurately diagnose the disease. Most reputable economists agree that what ails the Eurozone, along with much of the industrialized world, is a persistent lack of aggregate demand.”
Facing this prospect, the Eurozone’s course of action should be straightforward. Monetary policy, the process by which a central bank sets interest rates and controls the money supply, in the Eurozone has been extremely loose, from quantitative easing (80 billion euros a month) to the novelty of negative interest rates. The ECB should stay the course.
In the rich but slow growing core countries of the Eurozone—France, Germany, the Netherlands, and Austria—the private sector is reluctant to spend. Hence, governments should pick up the slack. Fiscal policy in these countries must become more accommodating. Borrowing costs have plummeted to historic lows in these countries. Any and all infrastructure needs in these countries should be taken care of as soon as possible. Such expenditures, likely totaling hundreds of billions of euros, might even improve the long-run debt scenarios of these countries, as deferred maintenance of infrastructure can extract a higher price later when real interest rates creep back up. If ever there were a time to be a fiscally profligate German, it is now.
Moreover, such spending may resolve two additional problems. First, increased economic activity in the Eurozone core may lead to above-target inflation of two percent. Overshooting the inflation target in these countries would be welcome, for as long as inflation remained in the single digits it could easily be quelled by raising short-term interest rates, and would extract the Eurozone from its current “lowflation” trap; this is inflation low enough that it effectively works as deflation, hindering growth as consumers and businesses postpone purchases in the expectation that prices will be lower at a later date.
Second, greater economic growth in core countries will have ripple effects that will positively reverberate in the struggling economies on the Eurozone’s periphery. If Germans or Dutch have more money to spend, they are more likely to use their added disposable income on things such as a vacation on a Greek island or a car designed in Germany but manufactured in Spain.
In the meantime, what should the economically weak periphery countries do? Largely, stand pat. These countries suffered greatest during the 2008 crisis and their debt-to-GDP ratios skyrocketed. They simply do not have the fiscal leeway for increased public expenditures. Rather, all of these countries, with varying degrees of success, are in the process of fiscal consolidations. While doing this, and without the benefit of having their own currency, they are undergoing slow and painful internal devaluations so as to have their private industry regain competitiveness vis-à-vis the rest of the Eurozone and the broader world economy. This process is not perfect, but with it, these countries have regained access to credit markets and have seen economic growth return.
If all of these policies were adopted, happy days would be on the horizon. Yet, the most likely result is that none of this will come to fruition. It is understandable that counter-cyclical fiscal policy, reduced taxation and increased spending during recessions and the opposite approach during boom times, is not intuitively grasped by the voting public in Germany and its neighbors. Not everyone is an economist and these policy positions are unpopular among large swathes of the European electorate. Ultimately, politicians accountable to these voters will not pursue them. It is not ideal, but it is also not the end of Europe. In the meantime, the Eurozone will continue to have to muddle through.
Image: ECB General Council Meeting on 18 December 2014 (European Central Bank, Creative Commons)
Marco F. Moratilla works for New Magellan Venture Partners, LLC, a venture capital firm. He has experience at the National Security Archive and the U.S. House of Representatives. He holds an M.A. in international affairs from The George Washington University and a B.A. in political science from the University of California, San Diego. His work has appeared in International Affairs Review. A native Californian, he spent his formative years in Madrid, Spain.