AUG 7, 2017 4
Sylvester Eijffinger is Professor of Financial Economics at Tilburg University in the Netherlands.
TILBURG – Not too long ago, the European Central Bank’s actions were usually met with cheers. But more recently, the ECB has drawn criticism from not just bankers and economists, but also citizens and politicians.
With returns on fixed-income investments decreasing, investors are being forced into equity investments, which have become riskier and more expensive, owing to increased uncertainty about financial and economic stability. That uncertainty reflects the fact that the ECB’s extremely low interest rates are serving to prevent desperately needed structural reforms in eurozone countries with high deficits and debt.
The big question now is whether the ECB’s current monetary policies are doing more harm than good. The ECB’s official aim is to reach an inflation target of close to 2%. But despite massive liquidity injections, the eurozone’s inflation rate has fallen, indicating that there is insufficient demand in the real economy. Indeed, demand is stagnating because many companies cannot make investments until they have reduced their debts.
Moreover, eurozone countries are feeling the effects of falling oil prices and slower Chinese growth – two factors on which the ECB’s low interest rates have little bearing. Central banks can break an inflationary cycle by raising interest rates and creating a liquidity squeeze; but they cannot generate inflation through low interest rates alone. In other words, the ECB can step on the gas pedal, but if the clutch does not work, the car will not move; it will just create a lot of noise.
Accordingly, responsibility for ensuring Europe’s economic recovery rests with national governments. The ECB has pulled the eurozone’s proverbial chestnuts out of the financial fire. But in doing so, it has felt the hot breath of financial institutions, which had previously abstained from contradicting ECB President Mario Draghi’s policies, at least in public.
The ECB should, of course, maintain supportive monetary policies. But stronger eurozone countries such as Germany, Finland, and the Netherlands must now play the role of pioneer. To this end, the Eurogroup of eurozone finance ministers, headed by Jeroen Dijsselbloem of the Netherlands, should set the agenda. The European Commission should provide it with whatever help it needs through the so-called Six-Pack powers. And stronger eurozone countries should go beyond monitoring the Stability and Growth Pact to also enact sound stimulus packages and tax reforms.
The European Commission’s “Juncker Plan” for boosting investment should have involved a trade-off between France and Germany, whereby the former would pursue structural reforms and the latter stimulus, with supplementary investments by the European Investment Bank. But the Juncker Plan has not gotten off the ground, and the eurozone has reached a stalemate, which is where it will remain until countries such as France and Italy feel more pressure to implement domestic reforms. Barring such reforms, Germany and the Netherlands will be unable to run modest budget deficits or encourage more domestic investment in infrastructure and research and development.
What is needed is a new presidium within the Eurogroup, comprising the French and German finance ministers, Draghi, ECB Vice President Vítor Constâncio, and representatives from the European Commission, including its president, Jean-Claude Juncker. Such a presidium would vastly improve coordination among the Eurogroup, the ECB, and the European Commission on stimulus and structural-reform measures and future interest-rate hikes. Ultimately, an informal presidium could also lay the groundwork for establishing a European finance ministry and fiscal union, if citizens and politicians prove open to that possibility.
As former ECB President Jean-Claude Trichet has long argued, the eurozone cannot function without a fiscal union. But to make that leap, Europe will need its own Alexander Hamilton – the United States’ powerful first Secretary of the Treasury.
After all, a fiscal union is not just a mechanism for sharing existing and new debt. It must also establish the conditions for fiscal policymaking at the national level, through balanced-budget rules and other measures. Just as Hamilton’s reforms shifted power from American states to the US federal government, eurozone countries would have to cede some degree of national sovereignty.
To be sure, such a shift in power would be momentous. But, at the end of the day, a fiscal union is the only viable solution to the eurozone’s structural problems. The Stability and Growth Pact is a second-best solution that will leave Europe stumbling from crisis to crisis.
History has shown that, to establish the euro, European policymakers first had to work together to align national policies and incentives within the European Monetary System. A new presidium within the Eurogroup could do the same for a fiscal union today.
But who will be Europe’s Hamilton? Right now, all eyes are on the most prominent leader currently calling for the establishment of a fiscal union and a eurozone finance minister: French President Emmanuel Macron.