A European drama
ANGELA Merkel, Chancellor of Germany, Europe's largest economy, is on a collision course with Mario Draghi, President of European Central Bank (ECB). Mr. Draghi has been urging European countries to abandon the strict diet of fiscal discipline and tight monetary control and undertake economic policies to stimulate their economies. Ms. Merkel, on the other hand, is encouraging her fellow European leaders to stay on course and let the easy monetary policy and other forms of economic aid, which are in the pipeline to run through its course, before letting go of fiscal discipline. This is a high-stakes game and the outcome may have widespread ramifications in light of recent evidence that the European Union countries have been struggling with high unemployment, slow economic growth, and increased possibility of “triple-dip recession.”
Recent economic forecasts have lowered the growth rate of Eurozone countries, i.e., the 18 countries that use the Euro as legal tender, from 1.2% to .8%. Mr. Draghi and ECB are now nervous about the possibility of a period of stagnation and deflation with the possibility that many of the large economies, excluding Germany, might find themselves bogged down in another cycle of low inflation and stagnant economic growth. Germany, fortunately, has been able to keep out of trouble, and Chancellor Merkel is advocating fiscal responsibility across the board, but particularly keeping an eye on Greece, Spain, Italy, and France.
The tension between these two sides, ECB and Germany, has heated up with Mr. Draghi encouraging Germany and other European countries to undertake expansionary fiscal policy and indicating that it is on the cusp of another round of quantitative easing as pursued by the US Federal Reserve System during 2009-2013 to buy sovereign debt with newly created Euros. Since ECB has already cut short-term interest rates to almost zero, and in some instances to negative rates, it is looking for instruments to keep Eurozone economies from stalling.
Angela Merkel and the parliamentarians in Berlin, along with Jens Weidmann, the president of Germany's central bank, Bundesbank, and his central bankers, in contrast see the concern voiced in ECB and the International Monetary Fund (IMF) as somewhat unnecessary fear mongering, and see great long-term benefit in continuing on the current path of fiscal discipline. Given Germany's fear of hyperinflation which date back to the aftermath of WWI, Merkel and Weidmann see the risk of hyperinflation that might ensue and consider the practice of printing money to buy government bonds as tantamount to reckless and suicidal behaviour.
The tension between ECB and Germany came to head a few months ago when German Constitutional Court ruled that the easy monetary policy of ECB, known as Outright Monetary Transactions (OMT), exceeds the mandate given to ECB. The Court listed a number of reasons why OMT may interfere with economic policy reserved to Member States. The matter was then referred to European Court of Justice and a ruling is expected early next year. Whichever way the ECJ rules, Germany will keep its options open and will likely throw more legal hurdles in the way of ECB's authority and even use the threat of breaking away from the Eurozone and revert to using the Deutsch Mark. Angela Merkel is not alone in her opposition to ECB's firefighting power. Luxembourg's Yves Mersch and France's Benoit Coeuere are both reported to be against government bond purchases, i.e., QE. They agree that easy money policy will be a disincentive for governments which ran fiscal deficit and accumulated debts in the past to continue with their reform programmes.
In recent weeks, it is Mario Draghi who seems to be winning with support coming from economists in America, US Treasury and IMF, among others. There is now a consensus among economists in the USA and UK that Europe faces an imminent threat of deflation and recession and there is an urgent need for both monetary and fiscal stimulus to forestall these twin threats. Many are worried that if Europe falls into what is now called triple-dip recession, an entire generation will face high unemployment and declining standard of living. Even Nobel Prize winning economist Paul Krugman threw his weight behind the call for QE. He labeled Germany as the bad guy among European nations for exercising too much fiscal restraint. A US Treasury report similarly argues that Germany's huge trade balance is “creating a deflationary bias for the euro area, as well as for the world economy.” It is reported that in October Germany had a surplus of €21.9 billion, or 8.25% of its GDP, and according to some estimates Germany's exchange rate is undervalued by 5% to 15%. There is now almost a chorus among economists and European officials calling for Germany to stimulate domestic demand and reduce exports, thereby promoting growth in the rest of Eurozone.
In the latest round of jousting, Draghi announced on December 4 that he might initiate new measures to stimulate the economic juggernaut. He sounded defiant when he said: “We don't need to have unanimity. It's an important monetary policy measure. It can be designed, I believe, it can be designed to have a consensus. I'm still confident, but we have to remember that we have a mandate, and as I said before, we don't tolerate deviations from our mandate that would cause ultimately a tightening, an unwanted tightening, of our monetary policy.”
German officials believe that “years of frugality and sacrifice have led to a strong economy, a full treasury and predicted budget surpluses.” Its European partners could reap the same harvest if they only follow Germany's example. In recent months, Ms. Merkel appears to have softened her stance as bad economic news keep pouring in, and even Germany's leading economic institutions have warned that German economy is stalling. She is also being pushed by domestic pressures to adopt policies that would actually be welcomed by most economists, the United States Treasury and many leading European officials, who have long argued that Germany needs to balance growth in the euro zone by stimulating domestic demand and reducing its dependence on exports.
Whether she can carry the rest of German financial and political establishment needs to be seen.
The writer is an economist who writes on international economic issues.