Credit where credit is due. Mario Draghi, President of the European Central Bank, has restored financial stability to Europe. But this victory has come at a heavy price and the question now is whether he can restore economic growth – or at least create the conditions for it.
It is always dangerous in economics to declare a victory – remember the end of boom and bust? But the fact that 10-year debt of Italy and Spain is trading at around 3.2 per cent and that of Ireland at below 3 per cent is pretty symbolic. Confidence has been restored. It is an astounding turnabout. Less than two years ago Dr Draghi declared (you might say was forced to declare) that he would do "whatever it takes" to save the euro. Well, for the time being at least, he has done so. The indebted fringe countries of Europe have been rehabilitated at least as far as investors are concerned, and – again, for now – talk of the eurozone breaking up has evaporated.
But financial success has been paralleled by economic catastrophe. Unemployment rates for much of the eurozone remain in double digits. Ireland, the poster boy for the fiscal consolidation imposed on the European Union countries that needed a bail-out, and one with strong economic underpinnings, has lost nearly 10 per cent of its population. If that is success, what on earth is failure? So, last week we had hints that the guns of the ECB would be swung round to target new objectives: avoiding deflation and generating growth.
We know none of the detail. All we have is some remarks by Dr Draghi that the ECB council was looking at new policy measures and that the discussion had included the possibility of quantitative easing (QE). However, he noted that since the European financial system relied more than others on bank finance, rather than market finance, any measures the ECB might take had to take that into account.
The point is that whereas the Federal Reserve and the Bank of England could pump money into the financial system by buying government bonds, that is very difficult under the ECB charter. The ECB supported bond markets by a promise to buy sovereign debt if markets became disorderly and this promise, you might say threat, was enough to pull down bond yields. It also helped the bond market indirectly by pumping money into European banks, which in turn invested in their countries' sovereign debt, making a big running profit on the deal. But it did not do QE in quite the same way as the United States and UK.
Now it looks as though the ECB may increase funding to banks with some sort of requirement that they lend to the wider economy rather than fund governments. Or it may buy private-sector debt itself. Other ideas are being planned – we just don't know what.
But it has to do something. Growth forecasts for the US and UK are running at close to 3 per cent this year and for the next three years. The eurozone will struggle to grow by more than 1 per cent this year and forecasts are for growth of around 1.5 per cent going forward. Inflation in the US and UK looks like being a little below 2 per cent this year, whereas for the eurozone it looks like being under 1 per cent. It was 0.5 per cent in the year to March. If you want to be legalistic, the ECB mandate is to keep inflation close to but below 2 per cent. If you want to be practical, deflation makes it very hard to grow. Look at what has happened in Japan.
My best guess is that the ECB will bring in measures, probably quite soon, to try to both check a slither into deflation, and boost the flow of funds into commerce and industry. These will, in a narrow sense, be a success. Europe will avoid deflation and there will be enough overall growth to pull even the laggards into modest growth. Unemployment will stop climbing, living standards will stop falling. The problem – and this is a political issue in the UK too – is that, Germany apart, the eurozone will not be a success zone. Growth of 1.5 per cent is not enough. Tensions within Europe between the winners and the losers were acute. Now they will become chronic.
What Europe, or indeed the UK, does to improve its long-term growth is too huge a subject to tackle here. But what you can see is that this cannot be the role of the ECB. Central banks can help economies dig their way out of recession by having a loose monetary policy, though this too carries costs. But they can do little or nothing to lift long-term growth.
That, I think, will become the principal frustration in much of the eurozone over the next three years. The rest of the world will be growing strongly, perhaps at double the rate of the eurozone. The young people will still be leaving to get jobs. What, they will ask, are we doing wrong?