In a speech at the Jackson Hole gathering of central bankers last month, ECB President Mario Draghi called for monetary and fiscal policy to boost demand alongside reforms to reduce structural unemployment, and he has now backed that call with action: in deciding to buy asset-backed securities, the ECB has begun a form of quantitative easing. This looks very close to Abe’s “three arrows” of QE, higher public investment and structural reform.
However, this interest in Abenomics in Europe comes as its effects upon the Japanese economy are wearing off. Economists expect Japanese real GDP to grow by a mere 1.4 per cent this year and 1.2 per cent next. The impact of Abenomics, says Christian Schulz at Berenberg Bank, “is temporary and shows signs of fading.”
A big reason for this is that the most powerful of those three arrows is being fired in the opposite direction. Fiscal policy, far from being used to stimulate the economy, is in fact depressing it. A rise in the consumption tax in April led to a slump in retail sales. The OECD estimates that overall fiscal policy will tighten by 0.8 per cent of GDP this year and 1.5 per cent next.
Exactly the same is happening in the euro area. On current plans fiscal policy in the region – on the OECD’s measure – will tighten by 0.5 per cent of GDP this year and 0.4 per cent in 2015.
Japan, then, provides a warning to the euro area: if policy-makers fire only two of the three arrows, the region could suffer Japan’s fate – a burst of euphoria (the Nikkei index surged after the announcement of Abenomics just as European indices rose on the announcement of QE), followed by disappointment.
Certainly, the ECB’s decision to buy asset-backed securities (ABSs) isn’t a very powerful way to boost growth.
In theory, there are four ways in which doing so might help the economy:
■ In replacing less liquid assets (ABSs and covered bonds) with cash, it helps improve banks’ balance sheets, which might encourage more lending.
■ The promise to print money has weakened the euro, which should help exports.
■ If prices of ABSs rise, so too should prices of near-substitutes such as corporate bonds. That should reduce companies’ borrowing costs and so encourage investment.
■ If people believe that the ECB can raise inflation, tail risk should diminish. Right now, there’s a danger of a horrible vicious spiral in which deflation raises debt burdens which increases expectations of more fiscal tightening which in turn entrenches deflation. If the ECB can persuade people that this won’t happen, then business confidence and investment should rise.
On the other hand, however, it seems that the ECB will buy only better quality ABSs. But these are much like cash. Its form of QE might therefore run into the same problem that the Bank of England’s did; in exchanging one cash-like asset for cash, the economy gets only a small boost.
In fact, we don’t need theory to see the effects of QE. Japan’s experience this year shows that the benefits of QE can easily be offset by tighter fiscal policy. The same has been true in the UK. Our economy stagnated in 2010-12 when we combined QE with fiscal austerity. Small wonder then that people expect the same in the euro area. The ECB’s actions, says Trevor Greetham at Fidelity “aren’t enough to cause growth to come surging back in the euro area.”
What’s more, economists also question whether the reforms to labour and product markets which Mr Draghi has called for can raise growth. A recent paper by Jerome Hericourt and Fabien Tripier is sceptical. “Structural reforms take time to increase growth potential and may have recessive effects in the short run” they say. One reason for this is that while a weakening of employment protection laws might encourage firms to hire more workers, it also increases job insecurity which might cause workers to save more which would depress demand. Researchers at the OECD – an organization not famed for its leftist sympathies – have found “little or no association between employment protection legislation strictness and overall unemployment.”
The bottom line here is that if euro-Abenomics is to work, it needs that third arrow of fiscal loosening. There’s a reason why Mr Draghi has emphasised the need for fiscal policy to help growth - it's because monetary policy can't do much on its own. Oxford University’s Simon Wren-Lewis says it is simply “non-scientific” to think that looser fiscal policy is unnecessary when interest rates are around zero. “What Europe really needs is a much easier fiscal stance in countries like Germany but that isn’t likely” says Mr Greetham.
However, even fiscal policy can give only a short-term stimulus to growth. Which poses the question: what can governments do to raise long-term growth? The answer might be: nothing. John Landon-Lane of Rutgers University and Peter Robertson at the University of New South Wales have shown that, over long periods, developed economies grow at similar rates despite different policies. This, they say, suggests that "there are few, if any, feasible policies available that have a significant effect on long run growth rates". Perhaps, then, there is little that euro area policy-makers can do to avoid the danger of long-term stagnation – except hope.
