Some today will be disappointed that Mr Draghi is keeping dry what limited monetary powder he still has - but the nuance here is his gradual warming toward fiscal support.
“A lesson from Japan is that QE provides cash to lend, but cannot force consumers/firms to borrow. The euro-zone looks halfway down the Japan route. It too may be running QE/negative rates, but has yet to loosen the fiscal reins.
“Yet, austerity has pulled down its budget deficit from 6¼% of GDP in 2009 to 2% - below the 3% Maastricht test for EMU. We suspect this makes it easier presentationally for fiscally-prudent Germany and the ECB to ‘turn a blind eye’ to profligacy by the higher-debt members needing to maximise growth. With Greece losing a fifth of its real GDP since austerity and Spain/Italy running 45%/38% male-youth unemployment rates, reform fatigue - and populist parties - are building.
“‘Helicopter money’ is considered a next step, via targeted fiscal give-aways. This would go some way to aligning the euro-zone and Japan with the faster-growing US and UK, whose net fiscal positions have loosened the most in the long run. Together with on-going monetary stimuli, this would raise the chance of keeping the euro down to avoid deflation. A hitch is the absence of a region-wide fiscal agency. This precludes a unified giveaway akin to the US’s tax-rebate cheques ‘helicopter dropped’ to consumers in 2001 and 2008.
“But, this could still be done nationally, perhaps in a coordinated way, supported (by actions if not words) by the ECB’s bond buying. Given the ECB’s concern expressed in the spring about “political risk” (reform-reluctant populist parties) potentially contributing “to contagion and re-fragmentation” of the zone, it should at this lower deficit ratio, be seen as the lesser of ‘two evils’. Reform pledges could even become back-end loaded to allow growth to breathe and avoid credit downgrades.
“Either way, despite an improving periphery, it will take years before the converging countries can reclaim their GDP lost - with Italy and Greece’s real GDP, on a net basis, still yet to rise with the euro.”
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