There is a consensus over growth stimulus in the euro zone
There is a growing consensus that growth in the euro zone needs to be boosted. The recession is leading to a situation in an increasing number of countries where the fiscal deficit is no longer being reduced (
Meanwhile, despite the slowdown in domestic demand, the external deficit remains substantial in Portugal and is no longer being reduced in Spain,
So a depressive dynamic is emerging: declining activity and falling wages without any improvement in fiscal or external deficits. This has given rise to a growing view that action needs to be taken to boost growth in the euro zone. We will therefore draw up a list of policies that could stimulate growth in this region and gauge the likelihood of these being introduced.
The (possible/likely) policies to stimulate euro-zone growth
1. Faster wage growth in
Rather than an explicit economic policy, this is more the effect that full employment and high corporate profitability have on wage growth in
2. Fiscal stimulus in
Whereas other euro zone countries are having difficulty reducing their fiscal deficits,
3. European investments
It is often suggested that, since euro zone countries have no more leeway to boost their economy, stimulus needs to be carried out at the European level, either in the form of additional investments by the EIB or in the form of additional investments by European structural funds. A 10 per cent increase in investments both by the EIB and European structural funds (excluding agricultural policy) would mean an additional EUR 14 bn of investment per year.
4. Driving down long-term interest rates through ECB government bond purchases
5. A third VLTRO
The three-year repos in December 2011 and February 2012 enabled Spanish and Italian banks to obtain cheap funding at one per cent and finance massive purchases of domestic government bonds, which resulted in a temporary fall in interest rates on these bonds.
A fresh long-term repo would have two positive effects. It would help to finance the external deficits of
6. A cut in the euro repo rate
There is still some room for manoeuvre for a cut in the euro repo rate while maintaining a big enough margin between the repo rate and the deposit rate at the ECB. A 25 or 50 basis point cut in the repo rate would be justified in light of the euro zone’s growth outlook and the muted rise in unit wage costs. The cut would likely lead to a depreciation of the euro and bolster growth. We have projected that a 100 basis point cut in the repo rate would increase euro zone growth by 0.2 percentage point per year for two years with a 50 basis point cut by 0.1 percentage point per year.
7. Sharp depreciation of the euro
Even after its recent fall, the euro is still overvalued by around 10 per cent.
Despite the lack of buyers, the euro is depreciating only slightly because the euro zone has no external borrowing requirement. In order to obtain a sharp depreciation of the euro, the ECB would have to accumulate substantial foreign exchange reserves (mainly in dollars) without sterilising these reserves, i.e. adopting the same policy as emerging countries,
While a depreciation of the euro would increase activity in the euro zone as a whole, it would do little to benefit the least industrialised euro zone countries (
So which measures are likely to be implemented?
Faster wage growth in
However, we do not believe Germany will introduce a fiscal stimulus package (due to the refusal by the Germans to “pay for the others”), nor will there be a reactivation of the SMP (the monetisation of public debts jars with the ECB and Germany), nor foreign-exchange interventions to drive down the euro (due to the resulting monetary creation, since it would not be sterilised).
Meanwhile, the effectiveness of a VLTRO 3 is questionable: do the banks want to buy more government bonds at a time when interest-rate risk is still high and there will be other stress tests on government bond portfolios in the future?
We are therefore left with a stimulus consisting in EUR 14 bn in wages in Germany, EUR 14 bn in European investments and a 25 to 50 bp cut in the repo rate, which could add 0.2 percentage points per year to euro zone growth at best.