This would appear to be grounds for dynamic action on the part of both governments and the European Central Bank but such endeavours have been slow in coming. On the fiscal front, governments in southern Europe are constrained by their already high borrowing costs and the push for austerity limits the extent to which demand can be stimulated directly by public sector spending. This makes monetary policy more vital than ever.
The last few weeks have served as a fresh reminder that central banks are hardly powerless when they choose to take action. The Bank of Japan is moving aggressively on its 2% inflation target. The new governor has laid out plans to purchase ¥50 trillion in government bonds per year, an enormous sum. While there have been stated goals and objectives in the past, without strong actions to implement them, their influence on expectations and hence behaviour was limited. This is no longer the case, Japanese stock market rallied and the yen has declined in value. The real test will come in the coming year: whether Japan can deliver robust growth again despite a difficult global economy and its own demographic challenges.
To some, this reeks of monetising the debt and in all fairness, it probably should. There are understandable concerns about central banks financing government debts. While the Bank of Japan ostensibly intends to reverse its asset purchases in the long run, there can be little doubt that there will be losers as well as winners from this decision. Declining purchasing power and harm to savers are only the most obvious possibility but escaping the deflationary tendencies and the cycle of deplorable growth may well be worth it.
Now the ECB does not serve at the discretion of a single country but all the diverse nations of the euro zone. Some nations are more influential than others of course. Given northern European opposition to this sort of explicit intervention, what chance is there of pulling Europe out of the doldrums?
Surprisingly, there is room for hope. As the ECB takes on its expanded role as bank regulator, it has substantial discretion to influence credit formation, lending and therefore, real growth in the wider economy. One key area concerns the timing of Basel III regulations, which are set to force higher capital requirements precisely when the economy most needs more active lending. Another lever is stress testing and how such assessments are best integrated with effective bank resolution.
For insightful analysis of these issues and a possible way forward, read Jonathan McMahon’s nuanced take at https://events.wavecastpro.com/TheGoodBank/library. Sign in now to join the discussion.
The views and opinions expressed in this article are those of the authors and do not necessarily reflect the views of The Economist Intelligence Unit Limited (EIU) or any other member of The Economist Group. The Economist Group (including the EIU) cannot accept any responsibility or liability for reliance by any person on this article or any of the information, opinions or conclusions set out in the article.
