The eurozone needs a bigger boost than monetary policy can provide
Melvyn Krauss
ECB president Mario Draghi, left, could offer German chancellor Angela Merkel a grand bargain © Reuters
Germany is faced with a conundrum. It appears to be heading into its first recession in six years and most investors believe it and the rest of the eurozone need some kind of economic stimulus.
The European Central Bank is poised to respond at its September meeting, probably with rate cuts and asset purchases known as quantitative easing. But Berlin has long criticised QE as a disguised bailout to profligate southern European countries that ultimately will be paid by German taxpayers, and pushing interest rates further into negative territory will hit hard-pressed German savers and financial interests.
However, there is another way. There are growing signs that Berlin is preparing a fiscal stimulus package, as it did after the 2008 financial crisis, including measures to prompt investment and cut carbon emissions. Nothing has been decided yet but Europe could be on the threshold of some very important policy changes.
Outgoing ECB president Mario Draghi has already warned that monetary policy may not be enough to boost the eurozone economy. He and the rest of the central bank leadership should offer Berlin a grand bargain — if Germany pushes ahead with fiscal stimulus, the ECB would forgo its monetary stimulus package as long as Europe’s inflation picture does not further deteriorate.
The deal would give the ECB invaluable breathing room: monetary policy is being stretched to breaking point by having to bear the entire burden of fighting Europe’s faltering economy and too low inflation. A grand bargain would bring much needed balance to Europe’s demand management policies, a suitable finale to Mr Draghi’s tenure.
From Germany’s point of view, sidestepping a possible new round of QE and further interest rate cuts could be worth it, even if they are ordinarily sceptical of using fiscal policy to boost economic growth.
Without concessions by the ECB, it is an open question whether there would be enough political support in Germany for a fiscal stimulus even with the looming recession. But with the grand bargain and the ECB’s promise to hold off on monetary stimulus, the fiscal stimulus would be virtually guaranteed. Together they would lead Germany to provide the boost that it and Europe need.
Another advantage of this grand bargain for Germany is that it could help defuse US president Donald Trump’s protectionist threats against the nation. He has been openly critical of Mr Draghi’s plan to provide monetary stimulus. If such a package causes the euro to decline against the dollar, it could fuel possible retaliation from the currency warrior in the White House.
A grand bargain based on fiscal stimulus might well be looked on with considerable favour by Mr Trump, if it increased US exports to Europe without causing the dollar to appreciate. The deal could be portrayed in Washington as a victory for Mr Trump. At best it would lead the protectionist president to delay threatened tariffs on German cars and other exports that experts are convinced are coming in the next several months.
At the same time, if the fiscal stimulus works, the German economy will be stronger and better able to deal with Mr Trump’s protectionist tariffs, should they come.
Even though the case for a grand bargain is convincing, there is an important caveat to be kept in mind. Mr Trump has been pushing the US Federal Reserve to cut American interest rates aggressively. If it does so while the US economy is relatively strong, Europe might need a new monetary stimulus package to protect itself from a skyrocketing euro.
The more the US engages in “beggar thy neighbour” monetary policies, the less attractive a grand bargain in Europe will become.
The writer is a senior fellow at Stanford University’s Hoover Institution
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