Reports of Europe’s Recovery Are Greatly Exaggerated
Recent stirrings of optimism about Europe’s economy have been interrupted: New jobs figures and signs of a slide into deflation have ended some very premature celebrations. The region’s economic crisis isn’t over. The danger of a relapse into recession is real.
At its policy meeting Nov. 7, the European Central Bank ought to recognize this threat by cutting interest rates and taking other steps to ease monetary policy. The European Union’s leaders, meanwhile, should look hard at their long list of unfinished crash-prevention business and get on with it.
Until last week, the mood had been improving, if tentatively. Euro-area manufacturing picked up in the summer. Measures of confidence improved, stock markets were up and the euro strengthened against other currencies. Analysts congratulated the region’s troubled economies for bolstering their public finances and reforming their sclerotic labor markets: See, adjustment is working.
Then came last week’s inflation figures: Consumer prices in the euro area rose by just 0.7 percent in the year through October, the slowest rate since 2009. Financial markets weren’t impressed.
Ask Japan what happens if a country gets locked into a deflationary spiral. Falling prices raise real interest rates and severely tighten monetary policy whether the central bank likes it or not. The real burden of debt starts growing, making it harder -- if not impossible -- for struggling debtors to mend their balance sheets. Europe has plenty of struggling debtors. Avoiding deflation is vital.
The latest jobs figures were terrible as well. Euro-area unemployment in August was revised upward, to a record 12.2 percent from 12 percent, and that number showed no improvement in September.
The ECB’s benchmark interest rate stands at 0.5 percent. With inflation far below the central bank’s 2 percent target and falling, the central bank should cut the policy rate to 0.25 percent or less this week. With short-term interest rates so low already, however, that won’t suffice.
The U.S. Federal Reserve and (belatedly) the Bank of Japan are buying assets on an enormous scale with the aim of lowering long-term interest rates. This quantitative easing has risks, but in both cases, the evidence suggests it has worked. The ECB, though, has largely refrained. It bought bonds at the height of the crisis but neutralized the effect of the transactions on the money supply. It also undertook a big program of short-term lending to banks, but that’s winding down. No doubt there are legal and, above all, political impediments in the EU to Fed-style asset purchases, but these must be overcome, and the ECB is best placed to make the argument.
It isn’t just in the case of QE that politics has stalled progress. Almost any proposal for effective action raises that politically freighted question: Who pays?
The most important stalled reform is in banking. Another round of bank “stress tests” has just been announced -- and this time, the ECB says, it’s serious. But there’s still no agreement on what happens to the banks that fail the tests. It’s universally agreed that the euro area needs not just a single bank supervisor -- which it now has in the form of the ECB -- but also a single bank-resolution mechanism. That won’t fly, because Germany and like-minded countries won’t hear of bailing out failing banks or their financially stressed national governments.
This reluctance is understandable. But without a single bank-resolution mechanism, the euro project remains fatally flawed. The toxic link between distressed banks and distressed governments will remain. So long as that’s true, recovery will be held back and the euro area’s supposedly integrated capital market will be at risk of further splintering into separate zones. If the euro is to survive and its member countries prosper, a real banking union is indispensable.
The need for more effective cooperation in Europe isn’t confined to banking. Last week, the U.S. Treasury Department complained that German economic policies were slowing Europe’s recovery -- arguing, in effect, that the euro area’s members ought to set their economic policies with the interests of the wider euro area, not just their own, in mind. The timing of this complaint, which coincided with the scandal over the tapping of German Chancellor Angela Merkel’s phone, was awkward, but the substance was right nonetheless. Avoiding deflation in the euro area calls for a bit more inflation in Germany than Germany would wish. If Berlin vetoes that and the euro area falls back into recession, Germany won’t escape unscathed.
Europe’s economy is still in a bad way -- and in peril of falling into an even worse slump. Forceful monetary easing and real cooperation on financial and fiscal policy can’t wait any longer.
To contact the senior editor responsible for Bloomberg View’s editorials: David Shipley at email@example.com.