Is monetary easing the answer to Eurozone problem?

By Raz Koroh

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According to the European Central Bank president Mario Draghi, he is prepared to act to push up inflation in the single currency area, which at 0.2 per cent in December 2015 and 0.4 per cent in January 2016 is a long way off the 2.0 per cent level that the ECB estimates as conducive to healthy economic growth.  Even though it is common knowledge that falling oil prices and slowing economic growth in China and other emerging economies are distorting the real inflation rate, nevertheless ECB officials believe that other economic data such as wage growth and industrial production point to below expectation inflation rate.  There is a feeling that if low inflation rate persists, that the cycle of massive bond purchase program known as quantitative easing and liquidity pumping into the financial system will continue indefinitely.  Such a policy prescription indicates that ECB has run out of ideas or is resigned to following such policy simply as there is no other option.  Or is there?

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Here are two factors to consider.

PRODUCTIVITY.  It is common knowledge that there is a dividing line between Eurozone north and Eurozone south.  The north comprises the more productive economies such as Germany and Netherlands, whereas the south comprises the less productive economies such as Italy, Greece and Portugal.  But it had not always been like this, for before they got rid of their national currencies to adopt the euro, the southern economies were relatively more competitive because of their lower cost base.  This all but ended when they signed away their sovereign right to control their own monetary policies to the ECB, which to common knowledge is a parallel of the German central bank.  By converging their currencies with those of the north, the relative competitiveness of export businesses of the southern economies were effectively eliminated.  Combined with the divergent fiscal disciplines between the north and the south, then the stage was set to reverse and widen the productivity gap between the two Eurozone regions, and consequently the economic growth records and unemployment situations between them.

SINGLE MARKET.  Germany is the main driver of Eurozone unity for it knows that its export markets depend on Europe.  In 2011, it exported ten times as much to the rest of Europe as it did to China, with the Eurozone taking two-fifth of German goods and services, and its exports to the rest of the EU account for a quarter of Germany’s annual GDP!  Germany’s exporters are rightly worried that if bankrupt Eurozone members are allowed to go their separate ways, this will lead to a loss of competitiveness for Germany as the rest of Europe will once again be free to devalue their currencies against the euro, and this will likely spell the end of Germany’s economic dominance in Europe although it will rejuvenate presently uncompetitive economies like Italy, Spain, Greece, Portugal, and indeed also France.  Thus it is highly likely that Germany after studying the cost-benefit analysis of supporting the ECB policy of endless bailouts of Eurozone problems, will continue to finance such a policy.

Germany’s seemingly altruistic backing to repetitive bail-outs of Greece and Ireland in recent years clearly point to its unwillingness to let Greece set (for Germany) a scary precedent for other southern Eurozone economies to follow.  This will simply be a disaster for Germany’s economy and global economic standing.  So it the end, the ECB will continue to have a forever willing sponsor.

Comments welcomed.