September 13, 2014    5 minute read

Are we about to Get ‘Draghinomics’ in Europe?

   September 13, 2014    5 minute read

Are we about to Get ‘Draghinomics’ in Europe?

 The controversial and somewhat genius experiment created by the Japan PM coined “abenomics“ seems to have attracted  ECB president Mario DraghiThe so called Japanese economic superstar Shinzo Abe,  or better known as the Japanese Prime minister, essentially created  “Abenomics”, which is a three-part plan to rescue the Japanese economy from what would be stagnation and deflation.  Abenomics’ three components – or “arrows” –  are made up of massive monetary stimulus called quantitative and qualitative easing , which in sense includes more credit for the private sector; a short-term fiscal stimulus, followed by consolidation to reduce deficits and make public debt sustainable; and structural reforms to strengthen the supply side and potential growth.

It now seems that Mr Draghi is very interested in implementing a Japan style Abenomics plan to keep Europe on top of the game and to maintain Europe’s image as a financial powerhouse. The first step of “Draghinomics” would be an acceleration of the structural reforms needed to boost and fundamentally grow the eurozone’s potential output growth. Progress on such vital reforms has been disappointing as a number of countries haven’t made much effort at all. About time that Mr Draghi recognises that the eurozone is slow due to European conflict and impending referendums which are triggering Forex markets to tank sharply (sterling) and the recovery which seems to be volatile at the moment and prone to any sudden change in global markets. This reflects not only structural problems, but also other factors that depend more on aggregate demand than on aggregate supply constraints. So measures to increase demand are also necessary.

Here, then, is Draghinomics’ second arrow: to reduce the drag on growth from fiscal consolidation while maintaining lower deficits and greater debt sustainability. There is some flexibility in how fast the fiscal target can be achieved, especially now that a lot of front-loaded austerity has occurred and markets are less nervous about the sustainability of public debt. Moreover, while the eurozone periphery may need more consolidation, parts of the core – say, Germany – could pursue a temporary fiscal expansion (lower taxes and more public investment) to stimulate domestic demand and growth. And a eurozone-wide infrastructure-investment programme could boost demand while reducing supply-side bottlenecks.

The third element of Draghinomics – similar to the QE of Abenomics – will be quantitative and credit easing in the form of purchases of public bonds and measures to boost private-sector credit growth. Credit easing will start soon with targeted long-term refinancing operations (which provide subsidised liquidity to eurozone banks in exchange for faster growth in lending to the private sector). When regulatory constraints are overcome, the ECB will also begin purchasing private assets (essentially securitised bundles of banks’ new loans)..Quantitative and credit easing could affect the outlook for eurozone inflation and growth through several transmission channels. Eurozone stock markets could rise, leading to positive wealth effects. Indeed, as the likelihood of QE has increased over this year, asset prices have already moved upward, as predicted.

These changes in asset prices – together with measures that increase private-sector credit growth – can boost aggregate demand and increase inflation expectations. One should also not discount the effect on “animal spirits” – consumer, business, and investor confidence – that a credible commitment by the ECB to deal with slow growth and low inflation may trigger. Some more hawkish ECB officials worry that QE will lead to moral hazard by weakening governments’ commitment to austerity and structural reforms. But in a situation of near-deflation and near-recession, the ECB should do whatever is necessary, regardless of these risks. Moreover, QE may actually reduce moral hazard. If QE and looser short-term fiscal policies boost demand, growth, and employment, governments may be more likely to implement politically painful structural reforms and long-term fiscal consolidation. Indeed, the social and political backlash against austerity and reform is stronger when there is no income or job growth.

Draghi correctly points out that QE would be ineffective unless governments implement faster supply side structural reforms and the right balance of short-term fiscal flexibility and medium-term austerity. In Japan, though QE and short-term fiscal stimulus boosted growth and inflation in the short run, slow progress on the third arrow of structural reforms, along with the effects of the current fiscal consolidation, are now taking a toll on growth.

As in Japan, all three arrows of Draghinomics must be launched to ensure that the eurozone gradually returns to competitiveness, growth, job creation, and medium-term debt sustainability in the private and public sectors. Hopefully a lesson can be learnt from what Japan is doing and more sensible monetary methods can be implemented in the near future to combat the high risk economical policies currently available to countries worldwide .

 

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