As Europe displays more and more of the characteristics of Japan's lost decade in the 1990s, when the country was trapped by chronic low growth and inflation, the European Central Bank is moving closer to launching a radical program to restore growth and prevent prices from falling. That moment could come this week.
An increasing number of economists think that ECB president Mario Draghi will use the bank's regular rate-setting meeting on Thursday to announce a narrow form of quantitative easing through the purchase of asset-backed securities (ABS), probably in the form of bundled new bank loans. Other economists think he will wait. Almost all agree that the faltering recovery and plummeting inflation rates will demand an aggressive new strategy sooner rather than later to pull the 28-country euro zone out of its slump.
Economists at Deutsche Bank think Thursday is the day when the ECB will open a new front in the war against deflation and dying growth rates. "While the [ABS] program is unlikely to be technically ready yet, we expect the ECB to firmly commit to this approach," economists Gilles Moec and Mark Wall said in a note.
Economists at Société Générale are not convinced Thursday will emerge as the big day, but said the "ECB could still surprise. It could cut rates or announce an ABS purchase program."
But any form of quantitative easing would be resisted by Germany, which remains a staunch advocate of using austerity and economic reforms to juice up the economy. Germany argues that quantitative easing would be a short-term fix, one that might remove incentives for governments to mount a serious reform campaign to make their economies more competitive. It also fears that the surge of liquidity that would be unleashed by quantitative easing could work too well and trigger high inflation down the road.
In a town hall event in Berlin on Sunday, German Finance Minister Wolfgang Schaeuble said that the countries that adopted austerity programs in exchange for bailouts – Greece, Ireland and Portugal – are "doing much better than all the others in Europe. That's how it is with medicine. Sometimes it tastes bitter for a while. But if it helps, that's good."
In a Bloomberg Television interview last week, Mr. Schaeuble said that "Monetary policy can only buy time. Liquidity in markets is not too low, it's even too high."
The leaders of France, where growth has fallen to zero, and Italy, which is back in recession for the third time since the 2008 financial crisis, are not buying the German finance minister's line. They argue that austerity has made their economies worse and vow to ease back on the tax hikes and spending cuts that they blame for destroying growth and keeping the jobless rate at double-digit levels. "Austerity in France and Italy has already died politically," said Nicholas Spiro, managing director of Spiro Sovereign Strategy, a London investment consultancy. "The question now is whether the more important structural reform agenda suffers the same fate."
Mr. Draghi himself has conceded that austerity accelerated the euro zone downturn. In a speech at the Jackson Hole central bankers' conference on Aug. 22, he called he said the ECB was open to a "more growth-friendly composition of fiscal policies."
A year ago, talk of quantitative easing in any form – the purchase of asset-backed securities or sovereign debt to boost liquidity, reduce real interest rates and free up bank capital for lending – was off the table.
That's because the worst of the financial crisis was over, Greece was not in danger of bolting from the euro zone and growth had returned. The optimism proved short lived. Since then, growth has all but disappeared in the euro zone. Even Germany, the touted engine of European recovery, saw its economy contract by 0.2 per cent in the second quarter. Economists have been lowering their economic growth predictions for the euro zone. Société Générale now expects growth of only 0.8 per cent his year, down from its previous forecast of 1 per cent, and 1.2 per cent in 2015. Meaningful unemployment reduction is impossible when growth rates are that anemic.
Inflation continues to fall. At last count, it was running at 0.3 per cent, less than a sixth of the ECB's target rate of close to 2 per cent. The ECB fears that disinflation could turn into outright deflation – falling prices – which could strangle any recovery. When prices fall, consumers and businesses withhold spending, on the assumption that services or equipment will cost less in the future.
The euro zone's weakness was highlighted again on Monday, when the purchasing managers' index for manufacturing for August, compiled by the economics and market data company Markit, fell to a 13-month low of 50.7 (any figure below 50 signals contraction). Manufacturing contracted in France and Italy, the region's second- and third-largest economies.
With a deteriorating growth outlook and chronically low inflation, it appears that the purchase of asset-backed securities, if not full-fledged, U.S.-style quantitative easing, is just a matter of time.
The credit-easing program, announced in June, is to start this month. It will see the ECB flood the euro zone banks with cheap liquidity to stimulate lending. It appears the purchase of asset-backed securities won't be far behind. The question is whether economic reforms will wither if the ECB rushes to the rescue with asset purchases, as the Germans fear.
Eric Reguly