(Reuters) - It may well be a big deal that Mario Draghi is now talking fiscal stimulus, but the unlikeliness of this happening only underscores that he’ll be forced to do more with monetary policy.
The European Central Bank president delivered a ground-breaking speech at Jackson Hole, calling for government spending to do more of the heavy lifting of bringing idled workers back on the job while acknowledging that, his previous excuses aside, market prices show he is losing the battle against falling inflation.
All of this is refreshing, and would be highly encouraging but for some pesky realities.
Euro zone countries are not likely, any time soon, to engage in any meaningful stimulus through government spending.
And monetary policy faces pretty severe mathematical, structural and cultural constraints. Zero is a barrier that is pretty hard to get below, and quantitative-easing-style maneuvers face their own issues. Not only is there only a small market for asset-backed bonds, which the ECB is likely to eventually start buying up, but there is a taboo, made flesh in law, on the central bank providing direct financing to member governments.
One thing Draghi did achieve, and should be able to sustain, was weakening the euro, which fell to near one-year lows against the dollar. Currency trading being a game about relative strength, Draghi’s comments, even if not backed with as much action as they would seem to warrant, show that policy will be more accommodative in the euro zone than in the U.S.
Draghi is both blessed and cursed by being perhaps the only major figure in the euro zone drama who can act both quickly and with some force. That was clearly shown with his electrifying “whatever it takes” comments in 2012, when he more or less single-handedly backstopped the euro project against disaster.
But though he has more scope for action than, say, French President Francois Hollande, who is currently trying to reconstitute his government, he faces very real limitations when we come round to defining ‘it’.
The market view, in the wake of the speech, was that this brings us closer to outright QE in the euro zone. This is probably correct, but possibly slightly beside the point.
Draghi is asking for help from the fiscal authorities because it is obvious that help is needed, that the current mix of semi-austerity and loose but constrained monetary policy is not sufficient. But the problem with saying that is that it ultimately brings the focus back to the peculiarities in European arrangements which helped to create this state and which have not changed.
“Reading the fine print of the Stability and Growth Pact, and taking account of political constraints, we do not expect to see any significant shift in the region’s fiscal policy,” economist Michala Marcussen of Societe Generale wrote in a note to clients.
Under the Stability and Growth Pact, which governs fiscal policy by euro zone countries, each is enjoined to keep structural budget deficits at no more than half a percent of GDP and act to reduce public debt to 60 percent of GDP over two decades. German Chancellor Angela Merkel agreed over the summer that countries should have more time to meet those targets, but only if their budget deficit is less than 3 percent of GDP. Scanning the list of member states we find that only Italy and Germany might qualify, and potentially be candidates for expansionary spending.
Well, Italy is currently in a recession which is about to make a mess of its budget, and Germany seems a politically unlikely candidate for single-handedly spending the euro zone back to fuller employment. Draghi did speak of a euro-wide budget for public works, but again, this may never happen and certainly won’t before he’ll be called upon to start buying up bonds.
This brings us back to the limitations on size and scope for bond-buying operations in the euro zone, and in turn, to the limitations on how much of an impact this might have.
In the U.S., where there is a large and deep mortgage bond market and a single government bond issuer, QE has been helpful, particularly in its earlier iterations, but hardly a sovereign cure for underemployment.
That brings us back to talking the euro down, something that may well prove to be Draghi’s biggest success, both at Jackson Hole and going forward. Monetary policy in Europe will likely soften more than that of the U.S. and all of this points up structural reasons for slow longer-term growth with more risk.
A weak euro will help, but may not be enough to get Europe out of the deflation danger zone.
(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at email@example.com and find more columns at blogs.reuters.com/james-saft)
Editing by James Dalgleish