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Draghi’s speech: end of austerity? Not really

, by Andrea Zorzetto

After years of “fiscal contraction” and “budget consolidation” in many European countries, the speech by the European Central Bank president Mario Draghi, at the annual conference for central bankers in Jackson Hole, Wyoming, has been interpreted by many as a call directed at European governments to act swiftly and decisively to bring about a long-awaited recovery.

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Exactly six years have passed since the bankruptcy of Lehman Brothers (which triggered the global financial crisis), yet the Eurozone is the only area of the world where growth is still sluggish. Indeed, data released during the summer showed that the economic outlook remains bleak: the average growth in the Euro area for this year’s second quarter was null, and so was for France; worse still, Italy’s and Germany’s - yes, even Germany’s - change in GDP was negative. Unemployment remains, especially in the South, at sky-high levels and the specter of deflation is becoming more and more real.

If the solution (austerity) tried to tackle the problem (long and deep recession) seems not to work, it would be reasonable to at least consider different approaches. Draghi was careful not to openly attack the way the crisis has been managed so far. Nonetheless, if we read through the lines, trying to decrypt the jargon, the message is clear: the structural component of unemployment has been overestimated and, given the intensity of the crisis, supply-side policies must be coupled with a fiscal stimulus. True, the ECB president underlined the fact that the parameters set by the infamous Growth and Stability Pact must be followed, however those countries that have more scope for action should intervene. The remark was clearly directed at Germany, which this year will deliver its first balanced budget since the reunification, despite a slowing economy and investment at its lowest level in decades. Considering that Draghi was probably restrained since he was addressing issues with which he should not be concerned, according to his mandate, the attack on austerity was quite explicit.

Draghi’s view is not far from what the IMF, not exactly a “leftist” institution, has been saying for more than a year, namely that the recessionary effects of tightening the government’s belt have been at least seriously underestimated. It has thus suggested more growth-friendly policies. The European commission also appears to be ready for a shift in thinking: the new president Jean-Claude Juncker, despite being a Christian Democrat who has said that “fiscal consolidation” cannot be avoided, has promised a 300 billion Investment plan to boost the Eurozone economy. The speech of Mario Draghi and his commitment to undertake unconventional monetary policies to stimulate demand confirms that also the ECB, or at least most of its board’s members, is worried that austerity programs have gone too far.

So if all the three institutions that compose the unpopular Troika seem to have changed their minds, will European governments finally have more scope to spend and try to help the economy recover?

Predictions in these cases are often likely to be wrong, however the chances that the end of austerity is near are low if the change of approach in Washington, Brussels and Frankfurt is not followed by analogous second thoughts in Berlin. Unfortunately Wolfgang Schäuble, Germany’s finance minister, has been quick to comment, a few days after the Jackson Hole speech, that Draghi has been “over-interpreted” and that governments cannot spend their way out of the crisis. The magazine Der Spiegel has reported that Angela Merkel has even called the ECB president to ask for explanations concerning the speech. So will Euroland countries together with the EU Commission and the ECB succeed in persuading Germany that more flexibility in the application of the budget rules is needed? So far the answer seems obvious, and unfortunately it’s negative. It is enough to look at the domestic situations in France and Italy to realize it.

These two countries are the biggest of the Eurozone after Germany, both in terms of population and GDP, and most notably their governments are led by (in theory) social democratic parties. Indeed many expected that the couple Hollande-Renzi could work as a counterweight to the German chancellor and obtain more balanced policies. Instead the French president has just reshuffled the government and sacked the economic minister Montebourg, who had called austerity a German obsession, responsible for prolonging the recession and increasing the danger of deflation. At the same time the Italian prime minister, while calling for more flexible euro-wide fiscal rules, has focused on structural reforms, especially of the labour market, as requested by Merkel and Schäuble. Whether these reforms are desirable or not, they will do little in the short run to reduce the dramatic scale of unemployment.

By and large, until the guidelines of the Eurozone management will remain blurry and more co-ordination of national macroeconomic policies, something Draghi has been calling for quite often in the last months, will remain utopic, the power vacuum will be naturally filled by Germany, for its size and for its primary economic role within the continent. As a result, policies that go beyond the “obsession with public debt” will hardly be pursued.

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Photo credit: Wall Street Journal

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