Mario Draghi is leading a forceful campaign to increase price levels closer to the 2% medium-term ECB target, denouncing dwindling inflation as a contemporary Guy Fawkes ready to blow up Europe’s economy. In doing so, he is patently aiming his guns in the wrong direction. Potential price hikes would further sap disposable income leading to lower expenditure. Moderate inflation, far from proving a significant stumbling block in securing recovery, helps to support demand. Failure to understand that lower wages exert a pivotal role in driving price levels downwards, leads to naive opinions and oversimplified diagnoses.
So long as dim employment prospects hold down salaries and downgrade working conditions, tough market competition will mean lower labour costs keep prices down. Private consumption also suffers from a squeezed payroll. The Eurozone real adjustment will inevitably involve footing such a bill. Overall, demand stimuli prove of limited use in reversing this trend so long as markets remain under heavy pressure.
Looser monetary policy does indeed help in bringing down financial costs and spurring confidence. Yet firms will not commit to higher investment and indebtedness levels while consumption lags behind. It´s hardly a paradox to surmise that bountiful liquidity fails to increase credit demand. Enterprises and households alike, profit from milder lending conditions; choosing to refinance their outstanding liabilities and deleveraging rather than increasing the debt on their balance sheets. Banks´ reluctance to take up extra funds from the new ECB facilities vividly shows the limited scope of monetary policy when the economy falls into a liquidity trap.
Only growth can aid the Eurozone´s woes. Yet setting up a robust, co-ordinated strategy for enhancing demand levels seems beyond reach, so long as countries running a surplus refuse to budge unless others partners initiate widespread reforms. While this tug-of-war goes on, the Eurozone could be headed for a prolonged period of sluggish performance. Betting on reforms for buttressing recovery seems a wholly misplaced goal. Not only will it take too long before they can affect any sizeable change, there appears to be little understanding as to how such a policy would be implemented.
Take for instance-France. Tackling its current rigidities would require an effective dismantling of the State grip on the economy-both in publicly owned and private companies. Neither sector makes key decisions without governmental oversight. Thus, any attempt to run the country on utterly free market conditions might severely disrupt the French economy for a whole decade. A gamble no government is willing to take.
Europe badly needs to be steered out of its current stagnation. Only decisive efforts by countries enjoying a comfortable margin of manoeuvre can do the trick. Even allowing reform plans to play a window-dressing role, the key driving force should rest on surplus economies expanding their domestic demand. Germany cannot go on slamming on the brakes while preserving a 7% external surplus plus a balanced budget.