With the Eurozone facing stagnation, a report issued on Wednesday, suggested that German aversion to inflation may grow as ageing concerns get increasing focus.
In the Financial Times today, Willem Buiter, a former member of the Bank of England Monetary Policy Committee and currently chief economist at Citigroup, writes that even if private domestic demand were to revive, either spontaneously or through external shocks or expansionary monetary and fiscal policy and supply-side reforms, the banking sector cannot support growth.
He writes that to avoid the cyclical stagnation in the Eurozone turning into secular stagnation, four policies are required with the first being more stringent bank stress tests followed by speedy recapitalisations.
The second measure is a temporary fiscal stimulus (say 1% of Eurozone GDP per year for two years, concentrated in the countries with the largest output gaps, that is, in the periphery), which is permanently funded and monetised by the ECB. To make the mechanics of this helicopter money drop more transparent, the ECB could cancel the sovereign debt it purchases.
This third measure would be economically equivalent to buying and holding the debt forever (rolling it over as it matures), but rather more dramatic.
Finally, to achieve debt sustainability, radical supply side reforms are required that boost the growth rate of potential output to at least 1.5% Italy, Portugal and other sclerotic countries.
Olli Rehn and Jean Arthuis who are members of the European Parliament and respectively former Commission vice-president for economic and monetary affairs; and chair of the European Parliament budgets committee and French finance minister, 1995-97, write that: "If persistent high fiscal deficit and increasing public debt resulted in rapid economic growth, then France and Italy would be European champions; Japan would be the world’s leading economic power; and Finland would be running the show in the Nordic area. What these countries have in common is a lack of appetite for structural reforms.
When Germany broke the terms of the stability and growth pact in 2003-04, it did so to implement a bold reform agenda that is unanimously applauded today. Should structural reforms be implemented in France and Italy, the European Central Bank would be reassured that its monetary stimulus was being channelled effectively through to the real economy to boost lending to enterprises and households."
Presentation: Banking & regulatory trends in Europe - from Deutsche Bank.
On Tuesday Deutsche Bank published a report [pdf] on inflation. It says:
Basically all factors influencing inflation attitudes as identified in cross-country studies are supportive for high inflation aversion in Germany. In two key areas of the economy determining its inflation propensity – private credit demand and the relationship between unemployment and inflation – we find quantitative evidence of rather limited inflation-accelerating properties.
The German peculiarities are a mixed blessing for the ECB. On the one hand, it makes inter-EMU rebalancing more arduous for the periphery and the reinvigoration of the credit multiplier more complicated for the ECB. On the other, it gives the ECB more time to run its supportive policy without creating new imbalances in the largest EMU economy.
In the long run, the arguments about what are the proper tasks and limits of fiscal and monetary policy, challenged several times in Germany’s highest court, show that there are still differences between Germans’ and other Europeans’ view of the world. Even more worrisome, the impact of demographic ageing in combination with strong preference for (low-risk) interest-bearing assets will probably make them even more inflation-averse, while high unemployment rates, soaring government debt and the need for deleveraging in the private sector might have the opposite effect in many other European countries. As a result, reaching a consensus on economic policy within EMU is going to remain very challenging.
Although we still think that the inflation cycle in the Monetary Union is about to turn, ongoing weakness and geo-political uncertainty do not hint towards strong cyclical forces driving inflation – probably not for years. Therefore the ECB has scope to extend its balance sheet via private and most likely public QE. "