Mario Draghi Searches for the Crash Mats
(Bloomberg Opinion) -- Like Nadia Comaneci at the 1976 Olympics, Mario Draghi might have hoped for a perfect 10 from anyone judging his performance as president of the European Central Bank. But an incipient slowdown in the euro zone risks spoiling his routine just months before he bows out. The ECB’s decision to end its net asset purchases at the end of 2018 is starting to look premature.
Last week, Draghi had to acknowledge that the risks to the currency union’s economy had shifted to the downside. A slowdown in China and the threat of protectionism are curtailing euro zone growth, which relies heavily on exports. Cheap oil and a strengthening labor market are positives. But the International Monetary Fund has just revised sharply lower its prediction for euro zone growth in 2019, after serious stutters in Italy and Germany. The ECB’s target of keeping inflation at slightly below 2 percent is at risk.
Draghi had warned that the euro zone would slow this year, but things looks worse than predicted. This raises questions about the wisdom of stopping quantitative easing. He committed to this step in June last year, but a little more patience might have avoided the potential embarrassment of this turning into a policy mistake.
The ECB would argue that suspending QE was the right decision at the time – and perhaps still is. In June, Draghi argued that the euro zone economy had escaped the risk of a prolonged period of Japan-style deflation, which is what prompted the asset purchases in the first place. He also says there are other tools that the central bank can use if needed, such as a new round of cheap loans to the banks. Finally, new asset purchases remain in the ECB toolkit, so they could be reactivated – in theory.
Yet when the ECB announced it was going to stop adding new bonds, core inflation was barely above 1 percent, well below the central bank’s target. Other factors, including not having enough German bunds to buy or Germany’s opposition to QE, may well have influenced the decision to withdraw stimulus. And even though the central bank has the tools to avoid further damage, it would have been far better to mitigate against the current blip earlier on. After all, it takes time for monetary policy to affect the economy.
Even if stopping asset purchases turns out to be a mistake, it wouldn’t undermine Draghi’s legacy. The ECB president will be remembered for his promise to do “whatever it takes” to save the single currency – a move that ended the euro zone crisis. Draghi’s combination of strong communication, economic intelligence and political nous makes him a tough act to follow.
But the ECB’s current awkward spot is a reminder that a star central banker cannot prevent the risk of policy error. The currency union has relied on Draghi to solve its problem of anemic growth. As his term nears its end, others, especially elected politicians, must pick up his baton.
The euro zone needs to rely less on monetary policy and more on other sources of growth. Fiscal policy should be used much more smartly. Germany, where the economy is slowing far more than expected, has ample room to boost domestic demand by launching a program of public investment. The German government is running a fiscal surplus, putting public debt on course to fall below 60 per cent of gross domestic product this year. Berlin is borrowing at an interest of below zero for up to 8 years, so a fiscal stimulus would be pretty inconsequential for public finances.
More infrastructure spending would help re-balance the German economy away from exports, fix supply-side bottlenecks and boost productivity. According to data from the OECD, output per hour worked in Germany rose by just 7.6 percent between 2010 and 2017. That’s merely in line with the rest of the EU. Public investment was a meager 2.2 percent of GDP in 2017, well below the 3 percent of early 1990s, according to Bruegel, a think-tank.
With a better mix of fiscal policy across the union, there would be fewer demands on the ECB to stimulate the economy. But it won’t be enough on its own. Europe’s political leaders must also take bolder steps to address the architecture of the monetary union. For one, setting up a centralized pot of money would give any country, especially heavily indebted ones, more breathing space during an isolated recession.
As he approaches the end of his term, Draghi has urged politicians to step up their efforts to shore up the currency union. His appeals have fallen on deaf ears. The euro zone will no doubt keep relying too much on its central bank. It’s hard to be perfect under that kind of pressure.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Ferdinando Giugliano writes columns and editorials on European economics for Bloomberg Opinion. He is also an economics columnist for La Repubblica and was a member of the editorial board of the Financial Times.
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