The euro zone is taking the same stagnation path as Japan – Analysis – Eurasia Review
By Daniel Lacalle *
The European Central Bank announced on September 9 a reduction in the buyback program. One would imagine that this is a sensible idea given the recent rise in inflation in the euro area to the highest level in a decade and the alleged strong recovery in the economy. However, there is a big problem. The announcement is not really down, but simply in adjustment to a fall in the net supply of bonds from sovereign issuers. In fact, given the pace announced by the central bank, the ECB will continue to buy 100% of all net sovereign issuance.
There are several problems with this strategy. The first is that the ECB reluctantly recognizes that there is no real secondary market demand for the sovereign debt of eurozone countries at these yields. We would have to think of two or three times the current yield for investors to accept many eurozone bonds if the ECB does not buy them back. It is obviously a dangerous bubble.
The second problem is that the ECB recognizes that monetary policy has shifted from being a tool to help implement structural reforms to a tool to avoid them. Even with the strong GDP rebound predicted by the ECB, few governments are prepared to cut spending and cut deficits significantly. ECB estimates show that after massive deficit spending in 2020, public spending in the euro area will rise again by 3.4% in 2021 to decline slightly by 1.2% in 2022. This means that public spending euro area will consolidate the increase in the covid pandemic with little improvement in the fiscal position of most countries. Indeed, countries like Spain and Italy have widened the structural deficit.
The third problem is that negative interest rates and heavy injections of liquidity combined with high public spending have not generated any real multiplier effect in the euro area. It should be remembered that the main economies were already stagnant in the fourth quarter of 2019, before the pandemic and despite major stimulus plans such as the Juncker plan, which mobilized hundreds of billions of euros in investments.
The fourth challenge for the ECB is that it recognizes that it is trapped by its own policy, it cannot stop it and normalize because governments and markets would suffer, and it cannot keep up with the current pace because of inflation. puts even more pressure on growth.
The final challenge for the eurozone and the ECB is that they continue to implement policies that ignore demographics and structural burdens on growth. The euro area has an aging population and monetary and fiscal policies seem to ignore evidence of changing consumption patterns when citizens reach a certain age or retire. If we add to the demographics a tax system that increasingly harms the middle classes, businesses and investments, we are faced with an economy that seems to follow all the bad policies implemented by Japan in the early 90s.
As Japan has done, the eurozone is banking all on public spending, policy-driven stimulus chains and massive debt monetization. However, the eurozone does not have the disciplined workforce that Japan does, nor the high levels of corporate and household savings that allow the country to continue to stagnate for decades.
Countries like Italy, Spain, Portugal or Greece cannot survive stagnation due to high levels of unemployment and the small size of the business fabric. Therefore, the ECB seems to ignore the risks of perpetuating perverse incentives to inflate public spending and debt. All the messages about structural reforms and real growth initiatives have disappeared in favor of targeted stimulus packages that never hold. Our duty as economists is to warn against the more than likely scenario of a poor recovery, low productivity and high debt facing the euro area. Fiscal multipliers have been negative for too long for us to ignore the negative crowding out effect of high public spending and the erosion of competitiveness the economy faces.
* About the author: Daniel Lacalle, PhD, economist and fund manager, is the author of the bestselling books Liberty or equality (2020), Escape the trap of the central bank (2017), The energy world is flat (2015), and Life in the financial markets (2014). He is professor of global economics at IE Business School in Madrid.
Source: This article was published by the MISES Institute