It's Too Little, and Too Late For the ECB

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The art of successful monetary policy is in the timing. Measures that might have worked a year or two ago might not be very effective today. Sadly, this would seem to be the case with the European Central Bank's (ECB's) latest monetary policy action. Bold as that action might appear to be, it comes at a time when Europe's economic and political problems have become deeply entrenched. Late in the day, it is too much to expect that monetary policy alone will succeed in turning around Europe's moribund economy or in improving the dismal state of its politics.

Ever since the onset of the European sovereign debt crisis in 2010, the ECB's policy response has been of the too little too late variety. Largely due to German reservations about monetary policy activism, the ECB was very slow to cut interest rates in response to its prolonged economic recession. More importantly, despite a marked decline in inflation to well below the ECB's target, of close to but below 2 percent, the ECB has proved painfully slow in adopting the unorthodox monetary policy measures that were practiced with relative success by both the Federal Reserve and the Bank of England.

The ECB's policy passivity has contributed importantly to Europe's abysmal economic performance over the past five years. This is underlined by the fact that at a time when United States' GDP is now some 8 percent above its pre-crisis 2008 peak, European GDP is more than 2 percent below that corresponding peak. It is also underlined by the fact that European unemployment remains stuck at 11 ½ percent and that the European economy has succumbed to outright price deflation. These developments are very much complicating the ability of Europe's highly indebted economic periphery to dig itself out from out under its debt mountain.

Equally troubling has been the deterioration in Europe's politics that has been spawned by its economic malaise. From Greece to Spain and from Italy to France support for Europe's traditional political parties is crumbling. Instead, we have seen the rise of anti-European and anti-austerity parties on both the extreme left and the extreme right of the European political spectrum. Absent an early improvement in the European economy, there is every prospect that this political rot will continue. This could pose a longer run existential threat to the Euro especially at a time that austerity fatigue in the European periphery is being accompanied by bailout fatigue in the Eurozone's core member countries.

The chances that the ECB's EUR 60 billion a month bond buying program will produce a quick turnaround in the European economy would appear to be very slim. European sovereign interest rates are already at very low levels and its privately owned housing market is very small in relation to that of the United States. In addition, unlike the United States where around 80 percent of corporate borrowing is done in the securitized debt market, 80 percent of Europe's corporate borrowing is done through the banking system. Until the European banking system is adequately recapitalized it would seem that the ECB's bond buying program will not be particularly effective in getting the economy going by further reducing borrowing costs.

Where the ECB's quantitative easing might have a salutary effect is through a cheapening in the Euro. Indeed, the large cheapening that has recently occurred in the Euro might be expected to gather pace in the months ahead since the Federal Reserve and the ECB now find themselves in very different phases with respect to the monetary policy cycle. However, it does not help that much of Europe's trade is internal and that Europe is having to compete with the Japanese and other important countries that are also engaged in policies to cheapen their currencies.

Hopefully, European policymakers will not remain in denial about the severity of the economic and political challenges that now confront them. Hopefully they also will not make the mistake of thinking that the ECB's actions alone will somehow save the day for Europe. Rather, one must hope that European policymakers now will act in a manner that might support the ECB's efforts to revive the European economy. For a start they could adopt labor market reforms and deregulate their ossified product markets in a manner that might promote much needed private sector investment. They might also bite the bullet now and clean up their banks' balance sheets with a view to get credit flowing again to small and medium sized enterprises.

Desmond Lachman is a resident fellow at the American Enterprise Institute. 

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