Mario Draghi is going out with a bang.
At his penultimate rate-setting meeting before he hands the whole sorry show to Christine Lagarde – the former boss of the International Monetary Fund – at the end of October, the president of the European Central Bank hauled out his bazooka for one last time in an effort to revive the European economy and stoke inflation.
The ECB is pushing interest rates deeper into negative territory, sending its deposit rate to minus 0.5 per cent from minus 0.4 per cent; relaunching the bond-buying program (known as quantitative easing, or QE) after a mere nine-month hiatus, at €20-billion ($29-billion) a month; and extending cheap loans to banks.
Mr. Draghi’s fresh stimulus package comes as Europe shows worrying signs of recession. Germany and Italy seem to be lurching back into one. Britain will almost certainly sink into the economic quagmire after Brexit. While Mr. Draghi said there is only a small chance that the 19 euro-zone countries, as a whole, will enter recession, the risk has “gone up.”
Will his package work? Locking in ultraloose monetary policy for several more years may deliver a marginal, but only marginal, lift to the economy and to inflation, which is better than nothing. What would do a better job is a hefty spending package, notably from tightwad Germany, which considers running budget deficits a moral failing.
“Central banks are running out of ammunition,” Andrew Sentance, an economist and former member of the Bank of England’s monetary policy committee, said in an interview Thursday. “Far better to tell the Germans to expand their fiscal policy.”
Mr. Draghi would agree. At the end of every rate-setting decision the ECB has made since he joined the bank almost eight years ago, he has pleaded with governments to get in the game on the fiscal front and work in tandem with the ECB’s monetary stimulus measures, one bolstering the other. He did so again Thursday, forcibly so. “Now is the time for fiscal policy to take charge,” he said.
His pleas have been largely futile – for good reason. In recent decades, governments have empowered central bankers to the point that they, in effect, became the default managers of the economy (and regulators of the commercial banks). Governments stepped back, as if they expected the central bankers to work miracles while fiscal stimulus was relegated to a secondary tool.
The process of empowering central bankers – mission creep, if you will – has its roots in the 1970s and 1980s, when high inflation was wreaking havoc with economies everywhere. Politicians and their lavish vote-buying habits were to blame. Together with trade unions, they gamed the system. Unions would ask for, say, a 4-per-cent pay increase, knowing they would get somewhat less. Governments would agree to 2 per cent or 3 per cent, then use high inflation to compress those wage gains. Repeat process.
After the inflation-era fiascos, the idea of truly independent central bankers took hold. They would be allowed to do what they thought best to contain inflation, boost employment and smooth out business cycles. The Bank of England got the nod from Tony Blair’s new Labour government in 1997, after which the chancellor of the exchequer had no right to call up the bank governor and casually suggest to him that rates should drop a notch or two. The ECB was formally launched a year later in preparation for the introduction of the euro. Both the Bank of England and the ECB were adept inflation busters, though more so the ECB.
The central banks came into their own during the 2008-09 financial crisis. It’s no exaggeration to say the ECB saved the euro from destruction in 2012, when Mr. Draghi said the bank would do “whatever it takes” to keep the euro zone intact. In came a raft of “unconventional” measures, including QE, which propped up the banks, prevented disinflation from turning into destructive deflation – outright falling prices – and pushed down interest rates and the value of the euro. At the time, governments weren’t doing much besides preaching austerity and praying that the central bankers’ voodoo would work.
Inflation went far too low – for years it has been running at about half the ECB’s target rate of almost 2 per cent – and economic growth never returned to robust levels. Now, growth and inflation are stalling again, and the ECB has little power left to reverse the situation. Take negative interest rates, which are designed to encourage commercial banks to open their lending spigots. If they stash their spare cash at the ECB instead of lending it out, they get charged. But will lowering rates by a mere one-10th of a point do the trick? Unlikely.
The slowing economy shows that central banks can only go so far. It’s time for governments to saddle up. That’s not to say central banks should lose their independence and become political creatures again (even if some leaders, notably U.S. President Donald Trump, would adore that), rather that fiscal policy has to be revived to pick up where the central banks left off. In Europe, that would mean persuading German Chancellor Angela Merkel to use spending to boost demand.
If she and other leaders continue to rely largely on the central banks to fix their economic woes, they are bound to be disappointed. Mr. Draghi is giving Europe one more shot of stimulus, then calling it quits. His message is that the ECB is tapped out.
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Eric Reguly