Mario Draghi, President of the European Central Bank (ECB), will step down on 31 October. He may well be remembered for his “whatever it takes” pledge to save the euro. His statement and supporting policies did shore up market confidence at the height of the eurozone sovereign debt crisis in 2012. However, critics say that such unconventional policies have also led to problems, such as an addiction to monetary stimulus and increasing wealth inequality.
During Draghi’s eight-year tenure, the main lending rate has been pushed to zero, some 2.6 trillion euros have been spent under the asset purchase programme, known as quantitative easing (QE), low-cost loans have been provided to commercial banks under targeted longer-term refinancing operations (TLTRO), and Greece is on track to recover from its debt crisis.
It is never an easy task to serve as the head of a central bank. While the U.S. Federal Reserve Chairman Jerome Powell faces pressure from the White House to keep interest rates low, Draghi is duty bound to balance the economic interests of the 19 eurozone member states.
However, the ECB’s QE programme – which started in the spring of 2015 and was halted at the end of last year – faced fierce opposition from some members of the governing council, particularly those from the richer northern member states. Bundesbank President Jens Weidmann and Dutch Central Bank Governor Klaas Knot are among the more hawkish policy makers and most vocal critics of the QE programme.
In contrast, people from the southern nations that were in deep trouble following the financial crash have more reason to be enthusiastic about Draghi, as he has consistently said that monetary policy has its limits and called on European governments to ramp up fiscal stimulus to boost growth.
Draghi will leave his nominated successor, Christine Lagarde, the now resigned head of the International Monetary Fund (IMF), stronger economic conditions compared to when he assumed office in 2011. In May this year, the unemployment rate in the eurozone was 7.5%, the lowest level since July 2008, while wage growth in the first quarter this year rose to 2.5% – the fastest pace since 2009. However, inflation remains subdued at 1.2% in June and is well below the official target of just below 2%.
Uncertainty over trade and Brexit, the rise of populism across the continent, and the current woes of Germany, which is the region’s economic powerhouse, mean that the new ECB head will have her hands full. At the same time, Lagarde will have less room to manoeuvre in the next crisis given that interest rates are already at rock bottom. As such, she might find achieving the key goal of the ECB – maintaining inflation rates below but close to 2% over the medium term – becomes more and more distant.
Owing to a challenging external environment, the IMF predicts Germany’s real GDP growth will slow sharply to 0.8% this year from 1.5% in 2018. The country’s car industry, which employs more than 800,000 people, is facing headwinds as the outlook for the combustion engine market dims due to tightened emission standards and the rise of electric vehicles. Some are wondering if the industry can survive its “iPhone moment.”
There are worries that softness in Germany, particularly in its export-oriented manufacturing sector, will infect other parts of the eurozone due to supply chain integration. With the German economy weakened, the IMF expects economic growth in the area will fall to 1.3% this year from 1.8% in 2018, before rebounding to 1.5% next year.
Monetary policy has its limitations, and will not work well without the support of fiscal policy. Low interest rates, rounds of QE and TLTRO, do not automatically create demand for goods and services in the real economy. After all, it is up to households and corporates to make decisions on whether to borrow more – even if the financial conditions have become more favourable due to accommodative monetary policy. Simply creating supply without enough corresponding demand is not the answer to the economic problems in the region.
While the eurozone basically has a common monetary union, it doesn’t have a fiscal union. Specifically, the eurozone lacks a “central fiscal capacity” to transfer money to particular countries to counter economic shocks. Such country-specific transfers cannot be achieved directly by ECB monetary policy, as interest rates are applied to all member states in the eurozone, regardless of their economies being overheated or deep in recession. There are concerns regarding the risk of moral hazard but even so, perhaps such a risk is more acceptable than the risk of a collapse of the currency union in a future financial crisis.