Europe's Descent Into Deflation

Mario Draghi and the ECB must stimulate growth now
Mario Draghi, president of the European Central Bank Photograph by Martin Leissl/Bloomberg

For a while, it was debatable whether Europe’s economy was recovering. No longer. Its recovery has stopped. The question is whether stagnation will tip over into something worse.

There’s no growth in the euro region. France is stagnant, Italy is back in recession, and even the German economy, according to revised figures, shrank in the second quarter. Admittedly, that’s partly because of the effect of sanctions against Russia—but the economic drag from the crisis in Ukraine isn’t about to end soon. Conditions are increasingly aligned for deflation.

What can the European Central Bank do? Its president, Mario Draghi, says the bank has already acted to stimulate demand, and in time the economy will see the benefits. Yet the package of measures the ECB unveiled in June didn’t amount to much. Europe needs quantitative easing of the kind the U.S. Federal Reserve has used to good effect—that is, bond purchases financed with newly created money. Forthright action can’t wait any longer.

Europe also needs to rethink its fiscal policy. That’s beyond the purview of the ECB, though it wouldn’t hurt for Draghi to demand changes. Again, he took a step in that direction in his recent speech, saying that fiscal policy should “play a greater role” in boosting demand. Then he took a step back by saying Europe’s Stability and Growth Pact allowed sufficient room to maneuver, and it would be “self-defeating” to abandon it. No. It isn’t a matter of finding room to maneuver. The pact, which tells governments to cut borrowing regardless of impending deflation, should be scrapped.

Draghi is right that the euro area needs structural reforms, including the deregulation of labor markets and investment in education and skills, but he’s wrong to suggest those are a higher priority than stimulating growth.

Monetary policy can and should do more. That’s the responsibility of the ECB. Europe’s governments can repair their fiscal policies, too—by jettisoning the fiscal pact rather than fiddling with it. If Europe’s long recession gets worse, it will be because its leaders saw what was happening yet chose not to act.

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