10 October 2014

Financial Times: How to break Europe’s economic taboos without shattering its union

Here is a glass half-full story about Europe: asset prices have rebounded, growth has turned positive, reforms are taking root and the drag from fiscal austerity is tapering off. Here is a glass half-empty story: growth has been too feeble to translate into employment gains, and private sector credit is still contracting. The optimistic narrative was popular for much of the past year. But the glass is slowly draining.

The near-stagnation in Europe has many causes. A big drag comes from households and companies that are holding back consumption and investment so as to pay down debt. The resulting shortage of demand impedes growth – and so undercuts the progress made in reducing debt-to-income ratios. Ultra-low inflation, and deflation in some places, also means the debt burden keeps rising relative to income. On the supply side too, wages and other costs are stubbornly high even as prices fall, discouraging hiring. Restrictions in product markets prevent new ideas from sprouting into the next big thing. Europe is not creating enough jobs. This strains the social fabric and frays public patience with the euro.

Calls to do something are growing but the answers tend to focus on one policy or another rather than a comprehensive solution. An exception is the “three-pillar” strategy put forward by Benoît Cœuré, a member of the European Central Bank’s executive board, and Jörg Asmussen, his former colleague and now a German government minister. But even their welcome proposal, in essence, is to do everything that is already being done, only a bit more energetically. The European Central Bank is already meeting its responsibilities (but should be ready to do more); fiscal policy should use the existing flexibility in the Stability and Growth Pact (but Berlin could use some of its budgetary room for manoeuvre); and so on.

Such tweaks will not deliver broad-based growth. Nor can German fiscal expansion, by itself, save the periphery: fiscal rules constrain Berlin’s hand, and anyway the impact of German spending on the eurozone would be small.

© Financial Times