Europe needs a 'Big Bazooka', but the ECB is preparing a peashooter

By Jeremy Warner

8:31PM BST 02 Jun 2014

Ever since David Cameron first coined the phrase back in the autumn of 2011, we’ve been forlornly awaiting the arrival of Europe’s “big bazooka”. This was meant to be the set of policy initiatives that would not just save the euro, and thereby forestall an even deeper financial and economic collapse, but set Europe back on the path to growth and stability — both prerequisites for any durable recovery in the UK.
On Thursday this week we get the latest instalment — more action from the European Central Bank to address the developing threat of price deflation, and the already established reality of economic stagnation across much of the euro area. What’s promised, however, is less big bazooka and something more akin to a peashooter. The imposition of a negative deposit rate, the effect of which is to penalise banks for holding reserves with the ECB in an effort to force them to lend, seems to be pretty much a done deal.
Further measures to incentivise lending — such as some kind of copycat version of Britain’s Funding for Lending scheme — may also be forthcoming. We can be pretty sure, however, that whatever the ECB governing council is able to agree, it will fall a long way short of the required “big bazooka”.
Neither the negative deposit rate nor a second round of the ECB’s long-term refinancing operation (LTRO), but with knobs on to incentivise lending to the real economy, will do the trick. Europe’s economic and political malaise requires much deeper surgery than a little monetary fiddling around the edges.
Europe’s mainstream leaders, nonetheless, continue to live in hope. And, admittedly, there are a few glimmers of it. The eurozone economy, as a whole, has stopped contracting, with most surveys now pointing to slow growth, even accepting the renewed slowdown reported on Monday by the latest PMIs. Both business and consumer confidence have improved a bit. What’s more, evidence from the US and Britain is that once the financial situation has been stabilised and the process of balance sheet restoration becomes sufficiently well advanced, recovery will automatically kick in, even against a backdrop of continued fiscal consolidation. In any case, Europe seems to assume that global recovery will eventually lift all boats, including the shipwrecked eurozone.
Normally I would go along with this analysis, but regrettably, the eurozone is something of a special case. It’s not just the policy constraints and compromises of the single currency, though as a barrier to recovery these are challenging enough; the more immediate reason is a near-12pc unemployment rate, with some countries experiencing levels of joblessness not seen since the Great Depression. As long as unemployment remains as high as this, it’s nearly impossible for countries to generate the internal demand necessary for durable growth.
Much of Europe remains mired in depression, with no obvious route to salvation. What makes this predicament much worse, of course, is that it doesn’t feel that way to the engine room of the European economy, Germany. Here, unemployment is just 5.1pc, which makes the idea of a depression seem almost laughable. The euro was meant to foster a sense of shared purpose and responsibility; but with the interests of the dominant nation still centre stage, it instead acts as a potent barrier to meaningful solutions.
To suggest remedies that might work is only to indulge in fantasy, for, as things stand, they are most unlikely ever to be enacted. Yet to spell out these options is to appreciate just how hopeless Europe’s position really is.
What Europe needs is a powerful dose of Abenomics, the radical mixture of monetary, fiscal and structural measures Japan is adopting to lift the country out of its 20-year economic funk. Europe requires the same. It needs full-scale and extensive quantitative easing, it needs a substantial fiscal stimulus, and it needs root and branch supply side reform way beyond the half measures forced on programme countries.
If the need for such policies wasn’t already apparent in the still dire state of the European economy, the results of last week’s European elections must surely have sent out the strongest of possible wake-up calls. Voters have sent out a clear and unambiguous message. Policymakers have lost the plot; they need to shift fast to prevent Europe sinking into ungovernable political and economic chaos.
A little bit of extra funding to Europe’s broken banking system falls pathetically short of these needs. That it has taken as long as this, with the European economy on the brink of price deflation, for the ECB to achieve the consensus necessary to inject further liquidity into the financial system tells us all we need to know about the paralysis that grips Europe’s experiment in monetary union.
I’m not saying it’s not worth trying. If it succeeds in bringing down spreads a bit, so that businesses and households in the eurozone periphery pay the same for their borrowing as those in the German heartland, then it may actually do a little good. Experience of Funding for Lending in the UK, on the other hand, is not particularly encouraging. Take-up of the facility for SME and even large corporate lending has been small to non-existent.
One thing the scheme has done, however, is demonstrate that the problem with business lending was not in lack of supply. It was lack of demand. For a long time, business has been in the mood to pay down debt, not to increase it, however freely available it was made. That mindset still very much grips large parts of the eurozone.
Meanwhile, the process of stress testing the European banking system against bad debts proceeds at glacial pace, with no one any the wiser on who is going to pay for the necessary recapitalisations if and when they are decided. Europe is teetering on the brink of full-scale “Japanification”.
Japan’s two lost decades should stand as warning enough, yet on almost every front Europe repeatedly shoots itself in the foot. Europe’s “fiscal compact” hard bakes economic stagnation into virtually all the eurozone’s highly indebted nations and thereby raises the bar yet further against any meaningful work-off.
There are occasional attempts to break free — most recently in both Spain and Italy — but the fiscal compact is now set in law and it is hard to see Germany easily giving it up. It was the price Angela Merkel, the German Chancellor, demanded for saving the euro. She would only add fuel to her own eurosceptic problem back home if she ceded ground.
Even on its own terms, the fiscal compact has failed spectacularly. As Marchel Alexandrovich, of Jefferies International, has pointed out, the compact was meant to lead to greater fiscal harmony in Europe. In fact, both tax and spending disparities between eurozone member states have increased over the past several years.
Europe’s high command has convinced itself the worst is over; with a little fine tuning by the ECB, decent growth will return. Would that it were true. Is there any chance of policymakers learning from the kicking they received in the European elections? Don’t hold your breath. There are too many egos, too many political careers riding on the status quo for them to admit they were wrong.