Economic commentators often like to refer to analogies of a medical nature and I will not shirk the custom. There are two long-term patients on the shores of the North Atlantic: the American economy and the European one. And there are two chief physicians who are scrambling to cure them: Ben S. Bernanke and Mario Draghi. The hospital stays of the two patients are similar in timing, although not in diagnosis or treatment.
For a few days now we have been witnessing the agitation that has arisen because the American head physician has announced to his patient that next year he will take away the dopamine with which, to various extents, has kept him up since 2007. It is appropriate to speak of dopamine because the American recovery is heavily drugged both by the strongly expansionary tone of fiscal policy and by Quantitative Easing (QE).
If we measure fiscal policy with the structural deficit – net of economic cycle trends – in the USA we have gone from a deficit equal to 2,8% of GDP in 2007 to values above 8% in the 2009-11 average, down only to 6,4% in 2012. Hence, US fiscal policy has been highly expansionary. Furthermore, with the multi-trillion purchases of government bonds and Mortgage Backed Securities (MBS), the Federal Reserve's QE has artificially inflated related prices, avoiding a possible chain of bankruptcies that would have jeopardized the economic recovery.
However, if the American patient is feeling better, as shown by real GDP growth above 2% (2,4% to be exact in the first quarter of 2013, above an average of around 2% in 2011-12) and renewed job creation, having achieved this through unprecedented stimulus may not be a stable outcome. Indeed, the recovery may not yet be consolidated enough to remove the dopamine: the very negative reactions of the stock market confirm this fear.
But there is more, the serious problem of the current account deficit remains open. It is true that from levels over 6% of US GDP in 2006 it has since dropped to around 3%. However, since the US is heavily indebted abroad, the adjustment would require surpluses and not further deficits (albeit small). In 2004, Sebastian Edwards estimated that the adjustment of the external deficit would cost the US a prolonged depressive effect on GDP growth of the order of over 3% per year. Whether Edwards was wrong remains to be seen. What we notice in the meantime is that the accentuation of American growth tends to produce new worsening of the current account deficit: taking the quarterly values of real GDP growth and the ratio between the current account deficit and GDP, there is a remarkable correlation positive (close to 0,5) between the two time series. Therefore, even if US growth were in fact lasting, it could lead to a further deterioration in the external accounts and, therefore, exacerbate those global imbalances which played such a large part in creating the fragility at the root of the crisis.
Things are quite different on the other side of the Atlantic. In the Eurozone, large doses of bromide have been administered instead of dopamine. Following self-imposed, wretched fiscal austerity, in the face of the worst crisis since the 30s, the structural deficit in the Eurozone was widened only slightly from 2,4% in 2007 to a mere 4,4% in 2009-10 for then contract it to 3,4% in 2011 and to 2% in 2012. The consequences, moreover highly asymmetrical among the member countries of the same currency area, made themselves felt with a real GDP that grew by only 1,7% in the 2010-11 average and reduced by 0,6% in 2012, when the recession of the countries experiencing sovereign debt crises extended to the area as a whole.
The European primary, Mario Draghi, who succeeded Trichet at the bedside of the patient at the end of 2011, worked hard but was only able to achieve partial results. Indeed, if you look at it as a whole, the monetary policy of the Bcs has moved in an expansive way. The ECB decisively lowered interest rates but the fundamental influence of the Bundesbank never allowed it to venture into QE interventions of a magnitude comparable to what the Federal Reserve was doing in the meantime.
Yes, it is true, in the presence of the unbridled speculative attack on the sovereign debts of peripheral countries, Trichet introduces the Securities Markets Program, with which the ECB intervenes on the secondary market preventing Italy and Spain from being completely brought to their knees. And then between 2011 and 2012 the new primary launches the Long Term Refinancing Operation (LTRO, granting 1% liquidity for one trillion euros to European banks) and in July 2012 boldly anticipates the Outright Monetary Transactions (OMT) to the City of London , operations hitherto never applied but the awareness of whose existence is sufficient to block the most unbridled speculation, because with them the ECB can buy, even to an unlimited extent, on the secondary market government bonds of the countries under attack), which it manages to get approved in September by isolating the Bundesbank.
If, on the one hand, we can congratulate our head physician because he managed to dispense a few doses of dopamine in Euroland as well, on the other, it must be noted that this dose of stimulant is certainly lower than that of fiscal bromide. And, moreover, an accommodative monetary policy means very little given the nature of the European crisis. Indeed, the capital market – even the banking market – of the Eurozone is spiraling and re-segmenting itself along pre-euro national borders. With government bond rates following diverging paths (up for the peripherals, down for Germany and the others not under speculative attack) the same policy implemented for all in Frankfurt becomes more expansive in Berlin, The Hague and the other "core" countries and more restrictive in Madrid, Rome and in the other peripheral ones. Therefore, the supply of credit is relatively abundant in the "core" countries while the peripheral ones suffer a prolonged and deep credit crunch. The LTRO can do nothing against this and even the OMT has little power.
In this situation, in which the liquidity disbursed by the ECB ends up largely parked in deposit accounts that commercial banks - afraid to lend to each other across national borders or, within the peripherals, to lend credit to economies in catalepsy for fiscal bromide – the chief is probably about to introduce some other innovative stimulant. Draghi's most recent press conference can be read in this sense. One intervention that seems to be being considered is that of introducing negative interest rates on deposits held by commercial banks with the ECB. This would be a completely unusual, but legitimate measure to welcome in these exceptional times. The European banks of the strong countries would thus be driven to lend also to those of the peripheral ones and the latter to give more credit to their economies which, otherwise, risk further weakening.
The fact remains that one day someone will have to explain to our grandchildren how we Europeans managed to bring this profound crisis upon us which could have been avoided, only if our leaders had been up to it. The confrontation with the USA is eye-opening. Overseas, a country with a strong and persistent imbalance in its external accounts has managed to restart growth by administering fiscal and monetary dopamine together and the only doubt is that the renewed growth is unsustainable because it could widen that imbalance. The Eurozone has no external imbalance – indeed, in 2012 it had a current account surplus equal to 1,2% of GDP – but the insane idolatry of austerity has administered horse doses of fiscal bromide to the peripherals and the The spiraling of sovereign debt crises has rendered even monetary dopamine ineffective there. It seems that in Frankfurt they are busy. But will Berlin and Brussels come to their senses in time?
