Opinion - Europe Economy

Europeans should protect and treasure their central bank

Key Points
  • The general unemployment and jobless youth rates are unacceptably high in more than half of the euro area, and 113 million people in the European Union are at risk of poverty and social exclusion.
  • The EU budget and trade surplus runners live off their European trade partners, refuse to stimulate their economies and oppose the ECB’s attempt to support growth and employment with easy credit conditions.
  • Preventing the ECB from offsetting fiscal restraint would lead to the replay of recent scenarios with rising unemployment, poverty and shameful soup kitchens.
European Central Bank President Mario Draghi testifies before the European Parliament's Economic and Monetary Affairs Committee in Brussels, Belgium September 24, 2018. 
Francois Lenoir | Reuters

Apart from its central bank and the fortress of its customs union, there is not much else Europe can show the world on its long march to the dreamland of the economic and political union.

Born of one of many French-German painfully resolved conflicts, the European Central Bank is a remarkable achievement. With good reason, it is generally taken as the world's only truly independent monetary authority.

And that's by design, not just because Germans love to boast that they imposed the model of their own central bank. No, it is much better than that by virtue of the ECB's supranational institutional and operational structure.

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Strong growth and stable prices

It is that particular feature that allowed the ECB's excellent president Mario Draghi to fight the headwinds of German-imposed fiscal austerity on sinking euro area economies and to lead the monetary union to economic recovery, strong growth and stable prices.

Strong growth? Yes, in the year to last June, the euro area GDP marked an average annual growth of 1.4%.

Why is that a strong growth rate? Because that pace of economic activity slightly exceeds the euro area's physical limits to growth set by the stock and quality of human and physical capital. That is also known as a potential and noninflationary growth rate, whose current euro area estimate is put at 1.3%.

Stable prices? Yes, the headline euro area inflation for last August was reported at 1%, with the core rate coming in at 0.9%. Those inflation rates are right in the middle of the widely accepted definition of price stability — i.e., the mid-point of a 0% to 2% inflation rate. Both inflation rates are well below the ECB's medium-term target of about 2% and are now the subject of a meaningless debate concerning the bank's present policy stance.

In spite of a calamitous pro-cyclical fiscal austerity and largely abusive labor market reforms, the ECB's easy credit conditions have provided effective support to a gradual revival of labor demand. In the process, the euro area unemployment rate fell to 7.4% last August, marking the lowest reading since pre-crisis times in May 2008.

That's still work-in-progress, though, because serious labor market problems remain in Greece, Spain, Italy and France — countries that represent exactly one-half of the euro area economy. Indeed, the jobless rates in those countries range from 8.5% (France) to 17% (Greece). In other words, the unemployment rate in one half of the euro area is significantly above the monetary union's average of 7.4%.

By contrast, the large trade and budget surplus countries like Germany and the Netherlands have some of the lowest unemployment rates of slightly above 3%.

The youth unemployment (people below the age of 25) also remains very high; its current rate of 15.4% refers to 2.2 million young persons searching for work. In six euro area countries — 53.3% of the total economy — the jobless youth rates range from 17.1% (Finland) to 33% (Greece).

Draghi's somber panorama

Lingering high unemployment has been one of the main reasons why the European Union failed to reach its poverty reduction objective since 2008. At the moment, some 113 million people in the EU are at risk of poverty or social exclusion, a far cry from the target of 92.6 million originally envisaged for 2020.

Can the euro area do better?

Of course it can, but in order to do that it needs to (a) correct its policy mix by establishing a proper equilibrium of monetary and fiscal policies and (b) implement structural measures to increase the stock and quality of human and physical capital to significantly raise its potential and noninflationary growth rate.

But that's a tough call for euro area surplus runners. They find it much easier to dump on the ECB and then blame the ECB.

Germany, for example, should not be able to get away with its "schwarze Null" (black zero) budget balance while living off its European partners that provide 70% of its massive trade surplus.

How the Europeans intend to get around that German problem is not clear. And yet, France and Italy in particular must figure that out because they are — cyclically and structurally — in a tight spot.

France unsuccessfully tried to appease its rioting "yellow vests" and associated constituencies with hefty handouts and tax cuts, ending up with a rising budget deficit to 3.2% of GDP for this fiscal year. A sharp decline of the projected deficit for next year to 2.3% of GDP looks problematic in view of a violent and unending social unrest, increasingly dangerous racial strife and political pressures from extreme left and right political parties.

And while the French ostensibly call Germans their friends, Berlin is not responding to the French request to step up public sector investments.

Italy's fiscal problem has temporarily receded from headlines because an improbable coalition was cobbled up to stop the right-wing political takeover with far-reaching consequences for Rome's EU and euro area memberships. But the fiscal difficulties will get worse. The stagnating economy is expected to move the budget deficit toward 3% of GDP.

All of that leads back to Germany — a country with an unstable and divided government, growing racial violence, social unrest, an ominous far-right surge in German eastern states and no clear direction on the way forward.

Investment thoughts

That uninspiring European economic, social and political panorama is what Draghi saw in his parting shot at another round of monetary easing.

Draghi also knew that the irresponsible German-Dutch cabal against monetary easing would lead again to economic and financial disasters, political crises, social upheavals and worse. He's seen that before on his own watch, when Europe's unbridgeable political divisions, age-old hatreds and appalling incompetence led to armies of poor, unemployed and shameful soup kitchens.

Draghi, an MIT-trained economist and a proven leader, will be sorely missed at the helm of the ECB. I only wish Europeans could have second thoughts on his departure – something like paraphrasing the iconic line from "Casablanca": "Play it again, Maestro Draghi."

Commentary by Michael Ivanovitch, an independent analyst focusing on world economy, geopolitics and investment strategy. He 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 Business School.