Time for Mario Draghi to open the sluice
The recovery in confidence is too fragile, and the revival of growth too feeble
Mario Draghi, president of the European Central Bank. Photographer: Jasper Juinen/Bloomberg
Mario Draghi, president of the European Central Bank, gave a clear indication last week that monetary easing would arrive in June. That would be welcome. It would also be too late and, in all probability, too little. Draghi saved the day in July 2012 when he announced that “within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And, believe me, it will be enough.” He needs to promise to do whatever it takes yet again, to eliminate excess capacity and raise inflation to 2 per cent. If he does not, crisis might yet return.
I had doubted whether the ECB’s programme for Outright Monetary Transactions would work. But this conditional promise by the central bank to purchase government bonds in the secondary markets proved so effective at stopping the panic that it never had to be carried out. Together with the commitment of vulnerable countries to austerity and reform, this has unblocked sovereign debt markets. Complacent policymakers and investors imagine the crisis is over.
One indication is the decline in yields on 10-year bonds. On May 8th, Irish bonds were yielding 2.7 per cent; Spanish, 2.9 per cent; Italian, 3.0 per cent; and Portuguese, 3.5 per cent. Even Greek bonds yielded only 6.2 per cent. These countries all ran current account surpluses last year, partly because domestic demand had collapsed and partly because competitiveness had improved. They no longer require net inflows of capital. Combined with the renewal of market confidence, this is reversing financing imbalances, which had left some of the euro zone’s national central banks deeply indebted to others. The OECD’s new Economic Outlook forecasts growth of 1.9 per cent in Ireland; 1.1 per cent in Portugal; 1.0 per cent in Spain; and 0.5 per cent in Italy in 2014. This is a welcome turnaround.
Yet at the end of last year these economies were 6-9 per cent smaller than before the crisis. Unemployment is very high, especially in Spain. Greece is in still worse shape. Furthermore, credit markets are yet to recover as the Economic Outlook also shows.
Above all, according to the OECD, by 2015 Spanish gross public debt will be 109 per cent of gross domestic product; Irish, 133 per cent; Portuguese, 141 per cent; Italian, 147 per cent; and Greek, 189 per cent. Even if bond yields remain at low levels and these countries run balanced primary budgets (before interest payments) indefinitely, nominal GDP must grow at close to 3 per cent a year (in the case of Greece, far more) merely to keep the public debt ratio stable. If they want to lower it, the budget must be tighter and growth higher – or both.
Growth of nominal GDP depends on real rates of growth and rates of inflation. But although higher inflation would ease the burden of public debt, vulnerable countries also need to improve competitiveness with core countries, either through higher productivity growth or lower inflation. In the year to March, core consumer price inflation in Greece, Portugal and Spain was negative, while it was 0.6 per cent in Ireland and 0.9 per cent in Italy. Yet overall euro zone core inflation was only 0.7 per cent and Germany’s 0.9 per cent. This makes adjustment hard. Suppose vulnerable countries continue with zero inflation. Then their economies need to grow at a real rate of 3 per cent to stabilise public debt ratios, unless they run primary fiscal surpluses. The OECD says Greece will run a structural primary fiscal surplus of 7.5 per cent of GDP, Italy one of 4.7 per cent and Portugal one of 3.5 per cent this year. Markets are betting such austerity will continue indefinitely. If – as is easy to imagine – it does not, crisis could quickly return.