Since the start of this year
the ECB has been applying “quantitative easing” (QE), i.e. a program injecting
large amounts of money in the economy. Every month the ECB is buying 60 billion
euros of government bonds and in so doing injects the same amount of money in
the economy. Up to today the total amount of liquidity injection approaches 700
billion euros.
There can be little doubt
that this massive injection of liquidity by the ECB has had a positive effect
on exports. It led to a depreciation of the euro vis-à-vis the major currencies
(dollar, pound sterling) and boosted competitiveness of Eurozone exporters to
the rest of the world.
However, it becomes
increasingly clear that QE alone is insufficient to pull the Eurozone economies
out of their lethargic growth. In fact, in the second quarter of this year,
growth slowed down again. There is a fear that in the next few years economic
growth will remain subdued. An expanded version of QE will not solve this
problem.
All this should not come as a
surprise. Economists have been warning for a long time that when interest rates
are close to zero, quantitative easing alone will not be able to stimulate the
economy. The reason is that when the interest rates are close to zero the
liquidity that the central bank is creating does not easily filter into the
real economy. Most of it is hoarded because the opportunities to find
attractive rates of return are limited. Many financial institutions then prefer
to accumulate the extra liquidity created by the ECB without doing anything
productively with it. This is the well-known liquidity trap.
Thus while QE was and is
necessary, it is insufficient. It has to be seconded by fiscal policies. Here
is the real problem in the Eurozone. Fiscal policies are not helpful. First,
too many countries continue to be kept into the austerity straightjacket.
Second, and most importantly, public investment continues to decline. But it is
public investment that is key to the recovery in the Eurozone.
There are two reasons why
public investment is central for promoting economic growth. First, the private
sector is still very risk averse and fails to invest enough. This has to do
with the lack of confidence in the future. The way to deal with this is for the
public authorities to show the way and to kick-start public investments. This
will increase economic growth and create more confidence in the future which
will stimulate private investment.
Second, public investment is
needed to achieve long-term objectives of a green economy. The latter requires
investment in alternative energy sources and in public transportation.
Unfortunately, public
investment is discouraged by a stupid rule that the members of the Eurozone
have imposed on themselves, i.e. that public investment cannot be financed by
bond issue. It has to be financed by current tax revenues. This prevents public
investment from taking off, from sustaining the recovery and from developing a
green economy.
It is often argued that
public authorities should not increase their debt; on the contrary that they
should reduce it. Some countries of the Eurozone periphery undoubtedly have
limited capacities to add to public debt. But other countries, like Germany,
France, Belgium and the Netherlands surely can. The governments of these
countries today can borrow at very long maturities almost for free. There are
certainly many investment projects that have a rate of return of more than 0%.
A government that issues
bonds at close to 0% and channels the money into projects that will have rates
of return by far exceeding 0% promotes economic growth and makes the future
repayment of the debt easier.
Put differently, what matters
in not gross debt, but net debt of governments. Debt issue that makes it
possible to invest in assets with a much higher rate of return than the cost of
borrowing (now close to 0%) will reduce net debt in the future. Unfortunately,
Eurozone countries continue to be mesmerized by gross debt numbers and as a
result fail to do the obvious.
It is often said that governments today should not issue more debt because this will place a burden on our grandchildren. The
truth is that our grandchildren will ask us why we did not invest in
alternative energy and public transportation, and thereby made their lives
miserable, when we faced historically favorable financial conditions to do so.
