Super Mario strikes, finally

28 Jan 2015


Mario draghi, president of the European Central BankExcept for the rare separatists, such as those who forced the Scotland vote last year, and other radicals of both the left and the right, politics in Europe is generally as dull as a normal day in England.

Even the French refuse to get too agitated by a president who takes a pillion ride on a scooter to visit his mistress, in the middle of the night. Imagine something like that happening in India. Every TV anchor in this country would instantly mutate to versions of Arnab Goswami, and keep screaming about morality in public life.

If Europe's politics is dull, decision making at the hydra-headed bureaucratic structure that is popularly known as the European Union is excruciatingly slow and painful.

The European Central Bank, a construct of the economic union, is only slightly better. When the US Federal Reserve under former chairman Ben Bernanke launched the mother of all quantitative easing programmes after the global financial crisis in 2008, the ECB limited itself to providing liquidity support to banks.

In subsequent years when Europe was in the midst of a credit crisis and staring at the possibility of some countries exiting the euro, the ECB started buying debt issued by some of the weak countries such as Spain, Portugal, and Italy.

Meanwhile, the US Fed followed up its QE1 with a QE2 and then a QE3. The British mostly followed suit. Later on, the Japanese got inspired and launched a quantitative easing programme of their own. On its part, the ECB refused to dip anything more than its toe in the great monetary easing exercise that was flooding the world with liquidity.

The Germans, who have always controlled the ECB's policy direction, were convinced that the risks of quantitative easing such as asset price bubbles and inflationary surges outweigh the potential gains. To many commentators, the ECB's course looked like the prudent and conservative option compared to the audacious policies followed by the Americans.

Now, finally, the ECB has taken the plunge. Mario Draghi has finally convinced his fellow policy makers that following the path set by the Americans is preferable than waiting indefinitely in the name of monetary prudence, while hoping for some miracle.

The scale and length of ECB's programme, as announced, have met most expectations. For those who are not satiated, Draghi held out the possibility of extending the bond purchases if the stated goals are not met. Draghi has been there before.

His promise in 2012, without any subsequent action, to do "whatever it takes" to defend the euro did more than any EU or ECB measure to save the common currency from doom.

Will the ECB's much delayed step work? In the short term, yes, most likely. Stock markets have rallied and there is more optimism among businesses, if comments from the recent World Economic Forum meet at Davos are anything to go by.

Banks are likely to lend more, now that the ECB is charging them to keep money with the central bank. That should help both businesses and consumers alike. This improvement in sentiment is likely to reflect in consumer spending and the job market in the coming months.

The euro has been weakening in recent months, in anticipation of ECB action. It is possible that the currency will slip even more and see parity with the US dollar, if the Federal Reserve increases interest rates this year as expected. Weak currency is almost always beneficial to exporters, and those in Europe should gain as well.

The longer term effect of quantitative easing is less predictable. Monetary policy on its own cannot revive long term growth. The central bankers can only try and smooth out the businesses cycles, to avoid excesses both on the downside and the upside. Quantitative easing is a last resort, when everything else fails to revive growth. It cannot help in the long term if the economy is facing structural weakness.

Except in select industries dominated by Germans, Europe is not very competitive. Its costs are high and the ageing labour force will only push up costs in the future. The region has rigid policies and politicians are always waiting with public cash to bail out failed businesses, which should be allowed to die. Unless there are large scale reforms to address these structural problems, it is difficult to see Europe's growth recovering to a more robust rate in the long term.

Then there is policy uncertainty. If the quantitative easing programme announced now doesn't yield results by next year, it is very much likely that the Germans would be all over Mario Draghi and his sympathisers. It worked in the US because, even in the face of criticism, Ben Bernanke refused to take his foot off the pedal when QE 1 and QE 2 yielded less than the Fed hoped for. Europe's politics could deny Draghi that luxury.

The price paid by Europe for ECB's procrastination has been huge. Seven years after the global financial crisis, when the US and the UK are enjoying healthy economic growth, the euro-area is staring at yet another recession.

Lack of demand is forcing prices lower, while businesses and consumers remain pessimistic. High unemployment and the decline in living standards have encouraged the growth of leftist movements across the region. Syriza's victory in Greece could be repeated in other countries as well. If Super Mario's latest bazooka fails, the region could face serious political and economic tumult for years.

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