The two key assumptions underlying the last policy easing decisions by the European Central Bank (ECB) are still being tested.
The first assumption was that the ECB's purchase of the euro area government securities would improve the banks' balance sheets by holding up the prices of bonds, which is the main asset class held by the banking sector.
Improved balance sheets and negative interest rates on bank deposits were then supposed to make banks more willing to lend to businesses and households to spend and invest.
Here is an interim report on all of these points.
The yield on Germany's benchmark ten-year government bond was 0.55 percent last Friday, exactly where it was at the beginning of this year. For many people, this single piece of data may be enough to make definitive conclusions about the ECB's policy effectiveness. I don't agree with that.
So, let's look a bit further. Surprisingly, the same bond yields in France are also unchanged since the beginning of the year; they are down 40 basis points in Italy, but they show a slight (6 basis points) increase in Spain.
That's enough now, because Germany, France, Italy and Spain account for nearly 80 percent of the euro area economy.
A slow grind
Is this record of bond valuations sufficient to give a provisional (low?) pass to the ECB's asset purchase program? I think it is.
And here is the next question: Has this policy moved banks to increase their lending to businesses and households?
The answer is yes. Last August, for example, the euro area bank lending to the private sector rose 1 percent from the year earlier – a big, but still a woefully inadequate, change from a 0.2 percent annual decline in January.
The composition of this increase is also a cause for concern. Business loans – an important signal because European companies mainly depend on bank credit for their investment spending – were showing a weak 0.4 percent growth in the year to August. Again, that is much too weak, but it is far better than an annual decline of 1.2 percent in January.
Bank loans to households are indicating a similar trend – they were growing at an annual rate of 1 percent in August, compared with a 0.2 percent decline observed in January.
All that is a modest result of the ECB's vigorous prodding of the banking sector with huge liquidity provisions. It is obvious that the euro area banks remain gun shy when it comes to extending loans for consumer spending and business capital outlays – the two key movers of economic activity.
And here is the punch line: Banks are still using most of their huge loanable funds supplied by the ECB to finance the euro area governments. Indeed, bank credit extended to euro area public sector entities soared 6.3 percent in the year to August, a sharp acceleration from a 2.1 percent annual increase last January.
Wars, refugees, elections
To understand what is going on with the transmission of the ECB policy, one also has to look at the private sector loan demand – a variable which is driven not just by the cost of credit, but also by household incomes, jobs and expected business sales.
The euro area's private disposable incomes marked a strong rebound last year with a 1.8 percent increase from 2013. That performance is unlikely to be repeated this year owing to weak labor markets. The area's jobless rate in August was 11 percent, roughly unchanged from 11.2 percent at the beginning of this year. A major country like France is still experiencing a steady increase in unemployment numbers.
These data explain most of the subdued bank lending to households. But I do expect a modest improvement in the months ahead on account of a small increase in disposable incomes and low credit costs. We can see that already: Retail sales in the first eight months of this year showed an annual gain of 2.4 percent, a clear indication that consumer spending in the euro area has picked up from a 1 percent growth in 2014.
All that, however, may not be enough to rev up the sluggish business loans. With the euro area growth rate of 1.3 percent in the first half of this year, firms have little incentive to expand their production facilities, because they apparently can comfortably meet their current and expected sales from existing plants and equipment. That is also indicated by a modest 1.5 percent increase in the euro area industrial production in the first eight months of this year. At that rate, output capacities are far from the point where firms need to expand factory floors and add new machines.
Being an act of faith in the unknowable future, investment decisions also critically depend on perceptions of the economic, social and political outlook. And that is where the euro area picture shows a number of ominously dark clouds.
The refugee crisis we are now witnessing is an intractable epochal event of biblical dimensions. Just think that nearly 3,000 refugees streamed into Slovenia last Saturday, most of them apparently turned away by Hungary's border closures.
These people are all on the way to Germany – a country expected to deal with an influx of 1.5 million refugees by the end of this year. Predictably, this unmanageable problem has caused political and social frictions. States and local communities of all political stripes are complaining that they are unable to cope with visitors who have to be housed, fed and offered health services and education. German law enforcement officials are also requesting an immediate restoration of border controls.
And all this comes at a time when Germany's largest automaker (and possibly some of its suppliers) is sued for serious wrongdoing on a global scale, and when its football officials are suspected of having bribed FIFA officials in order to host the 2006 World Cup.
France - governed by a president whose approval ratings just fell to 20 percent - is experiencing an unsettling economic, political and social environment, punctuated by the appearance of best-selling books on the country's identity crisis, with strident calls for an immediate return to its historical and cultural roots of a "white Christian nation."
And perhaps the most far-reaching event for the future of the EU is a case brought by Slovakia at the European Court of Justice in Luxembourg. Bratislava wants to test the legal foundations of EU Commission's orders to sovereign member countries. The suit is a challenge to Commission's imposition of mandatory refugee quotas vehemently refused by Slovakia and a number of other East European countries.
The ECB policy is gaining some traction with the real economy in the context of an increasingly chaotic economic, political and social situation within the monetary union.
Investors may wish to think of the possibility that risks and uncertainties raised by the ongoing refugee crisis could overwhelm the stimulus of low credit costs. One has to realize that the sources of this massive migration are raging wars in Afghanistan, Iraq, Syria, Libya and Central Africa – all of which are set to continue for the foreseeable future.
The refugee crisis is also exacerbating tensions within the German coalition government. It seems that these tensions could get much worse in the run-up to 2017 elections as Chancellor Merkel's grip on power continues to loosen. France is already in an ugly pre-election mood, with the center-right politicians competing for votes on extreme-right issues. Some of the key issues are anti-euro, anti-EU, and, regrettably, also virulently anti-German.
That is the environment where the ECB might have to fight harder to prevent a stalling, or a recessionary relapse, of the euro area economy. The ECB will do that – as long as its mandate is in place. But please bear in mind that this is not an irrevocable mandate.
Michael Ivanovitch is president of MSI Global, a New York-based economic research company. He also served as a senior economist at the OECD in Paris, international economist at the Federal Reserve Bank of New York and taught economics at Columbia.