Europe Must Rediscover Fiscal Policy

What he doesn't say is important.

Photographer: Jasper Juinen/Bloomberg

Investors weren’t expecting anything from European Central Bank President Mario Draghi on Thursday, and he delivered in full. The ECB’s policy is working just fine and doesn’t need to change, he told assembled reporters. Thank you for coming.

Draghi’s right: Things would be much worse in the euro zone if the ECB hadn’t tested the limits of monetary policy with its super-low interest rates and huge, ongoing purchases of bonds. Yet despite the ECB’s efforts, demand is still too low, growth is still too slow, inflation is close to zero, and Europe’s governments are doing too little about it.

Draghi has rightly and repeatedly called on governments to adopt more growth-friendly fiscal policies. At the same time, for understandable reasons, he tends to downplay the urgency of the situation. To reassure investors, he insists the ECB can use plenty more ammunition, if necessary, in its fight against deflation. And to avoid offending EU leaders, he also insists that any tweaks to fiscal policy should conform to the rules of Europe’s Stability and Growth Pact, which limits government borrowing.

Europe’s QE Quandary

In fact, the ECB no longer has good options for delivering additional monetary stimulus. Ramping up quantitative easing and making interest rates more negative might, in the longer term, do more harm than good by distorting financial markets. Fiscal policy therefore needs to do more -- but it’s hemmed in by rules that are absurdly complex and erratically enforced.

QuickTake Negative Interest Rates

Ideally, there’d be budget action on three fronts. First, change the fiscal mix to promote growth, for instance by prioritizing investment in infrastructure. This is allowed by the rules and is what Draghi recommends. Second, increase national budget deficits where this can be safely done, even if it violates the fiscal rules. Third, design an EU-wide fiscal policy that involves strong economies (such as Germany) giving temporary economic support to weaker ones (many of the rest).

The first approach is too limited to be much use, and the third won’t happen because Germany won’t stand for it. The best feasible course is the second -- soften and simplify the Stability and Growth Pact so that it promotes additional fiscal stimulus in more EU economies. It’s encouraging that European Commission President Jean-Claude Juncker is said to be considering an initiative of this kind.

If Juncker comes forward with a good proposal, EU governments should open their minds to the idea. It won’t be too soon. Draghi may be reluctant to admit it, but he needs all the help he can get.

To contact the senior editor responsible for Bloomberg View’s editorials: David Shipley at davidshipley@bloomberg.net.