It is big, but maybe not big enough. Size matters in public policy, and the size of the boost to the eurozone economy sketched last week by Mario Draghi, president of the European Central Bank (ECB), is huge. Even by the standards of public finance, a boost of at least €700bn (£556bn) should be big enough to punch some more demand into the economy. But it may not be enough to enable Europe to escape from stagnation. Other things need to happen. The threat hanging over much of the EU is that it will endure a lost decade, at least in economic terms, rather like the experience of Japan.
What is happening, will it work, and what does this mean for us?
There are two broad elements to the ECB action. The cuts in the bank's guideline interest rates, one of which was already below zero, are unlikely to have much real effect. The problem for Europe is not that money is too expensive; it is that you can't get it. Most would-be borrowers don't have access to credit, while most of those who could borrow don't want to do so. The impact has, however, been extraordinary. For example the interest rates on two-year notes for a number of eurozone countries, including now Ireland, have gone negative. In other words if you want to lend to the Irish government for two years, you have to pay to do so.
Unsurprisingly, German savers who see their own cash getting a near-zero rate in the bank are less than thrilled. They may get worried and try to save even more to offset the effect. If they, and other European consumers do so, this further negates the effect of near-zero rates. So the other parts of the ECB package, which we only have in outline, may turn out to be more important. The key thing here is that the ECB will buy packages of loans from banks, giving them cash instead. That is where the €700bn number comes in. Unlike the US and UK, where the central banks buy government securities under their quantitative easing programmes, the ECB is buying private sector stuff. It is not allowed to buy government securities, so it has had to resort to what you might call QE-lite.
That is what is happening. What should we look for to tell us whether or not it is working? The eurozone economy is growing, but only just. It looks as though overall growth will be somewhere between 0.5 and 1 per cent this year. Even successful economies, notably Germany, are stuck. It shrank in the second quarter and while the latest manufacturing numbers are decent and point to a better third quarter, forward-looking surveys are a bit glum. If these forward indicators improve in the next couple of months then we can relax a little. If not, the ECB will have to think of something else.
The other thing to look for will be progress on structural reform: simplifying regulation, making it less onerous to hire people, and so on. Such policies have normally been regarded as long-term ones. However, one of the under-written stories of the past few months has been the divergence in the progress of Spain, which has carried out important reforms, and Italy which broadly has failed to do so. Both countries face similar problems, are following similar fiscal policies, and of course have the same monetary policy. But whereas three months ago the consensus forecast for growth this year in Spain was 1 per cent, this has been upgraded to 1.2 per cent. By contrast for Italy it was 0.6 per cent – which has now been downgraded to 0.1 per cent. The pay-off for structural reform seems to be coming through much faster than the textbooks would lead us to expect.
All this affects us. This last point supports the UK agenda in Europe, stressing the importance of structural reform as a driver of growth. That makes Europe an easier partner for the UK in any negotiations. More broadly, if the eurozone economy does gradually improve, then that will help the business case for remaining a member of the EU. If your largest market is growing solidly, you don't really want to pick a fight with it.
If on the other hand, eurozone growth remains sluggish at best, that will push British perceptions in a different direction. The revisions to our GDP figures that came through last week, plus the next batch, are putting a very different perspective on the relative performance of the UK economy. Instead of being rather a laggard in the recovery, we have now become a leader – behind the US and Canada, but now pulling ahead even of Germany. Indeed, if you allow for changes in North Sea oil and gas output, this latest recession looks very similar to that of the early 1980s, rather than being the worst since the Second World War.
So there is a lot to play for. A more successful Europe rather spikes the guns of Ukip. But a lost decade for the European economy might shift the views of British business that it is in our self-interest to hang in. What the ECB is trying to do is nothing about us, but its success or failure will profoundly affect our relationship with Europe.Reuse content