Opinion

James Saft

Draghi calls for fiscal help, hears busy signal: James Saft

August 26, 2014

Aug 26 (Reuters) – It may well be a big deal that Mario
Draghi is now talking fiscal stimulus, but the unlikeliness of
this happening only underscores that he’ll be forced to do more
with monetary policy.

The European Central Bank president delivered a
ground-breaking speech at Jackson Hole, calling for government
spending to do more of the heavy lifting of bringing idled
workers back on the job while acknowledging that, his previous
excuses aside, market prices show he is losing the battle
against falling inflation.

All of this is refreshing, and would be highly encouraging
but for some pesky realities.

Euro zone countries are not likely, any time soon, to engage
in any meaningful stimulus through government spending.

And monetary policy faces pretty severe mathematical,
structural and cultural constraints. Zero is a barrier that is
pretty hard to get below, and quantitative-easing-style
maneuvers face their own issues. Not only is there only a small
market for asset-backed bonds, which the ECB is likely to
eventually start buying up, but there is a taboo, made flesh in
law, on the central bank providing direct financing to member
governments.

One thing Draghi did achieve, and should be able to sustain,
was weakening the euro, which fell to near one-year lows against
the dollar. Currency trading being a game about relative
strength, Draghi’s comments, even if not backed with as much
action as they would seem to warrant, show that policy will be
more accommodative in the euro zone than in the U.S.

Draghi is both blessed and cursed by being perhaps the only
major figure in the euro zone drama who can act both quickly and
with some force. That was clearly shown with his electrifying
“whatever it takes” comments in 2012, when he more or less
single-handedly backstopped the euro project against disaster.

But though he has more scope for action than, say, French
President Francois Hollande, who is currently trying to
reconstitute his government, he faces very real limitations when
we come round to defining ‘it’.

The market view, in the wake of the speech, was that this
brings us closer to outright QE in the euro zone. This is
probably correct, but possibly slightly beside the point.

A CABLE TO BERLIN AND ROME

Draghi is asking for help from the fiscal authorities
because it is obvious that help is needed, that the current mix
of semi-austerity and loose but constrained monetary policy is
not sufficient. But the problem with saying that is that it
ultimately brings the focus back to the peculiarities in
European arrangements which helped to create this state and
which have not changed.

“Reading the fine print of the Stability and Growth Pact,
and taking account of political constraints, we do not expect to
see any significant shift in the region’s fiscal policy,”
economist Michala Marcussen of Societe Generale wrote in a note
to clients.

Under the Stability and Growth Pact, which governs fiscal
policy by euro zone countries, each is enjoined to keep
structural budget deficits at no more than half a percent of GDP
and act to reduce public debt to 60 percent of GDP over two
decades. German Chancellor Angela Merkel agreed over the summer
that countries should have more time to meet those targets, but
only if their budget deficit is less than 3 percent of GDP.
Scanning the list of member states we find that only Italy and
Germany might qualify, and potentially be candidates for
expansionary spending.

Well, Italy is currently in a recession which is about to
make a mess of its budget, and Germany seems a politically
unlikely candidate for single-handedly spending the euro zone
back to fuller employment. Draghi did speak of a euro-wide
budget for public works, but again, this may never happen and
certainly won’t before he’ll be called upon to start buying up
bonds.

This brings us back to the limitations on size and scope for
bond-buying operations in the euro zone, and in turn, to the
limitations on how much of an impact this might have.

In the U.S., where there is a large and deep mortgage bond
market and a single government bond issuer, QE has been helpful,
particularly in its earlier iterations, but hardly a sovereign
cure for underemployment.

That brings us back to talking the euro down, something that
may well prove to be Draghi’s biggest success, both at Jackson
Hole and going forward. Monetary policy in Europe will likely
soften more than that of the U.S. and all of this points up
structural reasons for slow longer-term growth with more risk.

A weak euro will help, but may not be enough to get Europe
out of the deflation danger zone.
(At the time of publication James Saft did not own any direct
investments in securities mentioned in this article. He may be
an owner indirectly as an investor in a fund. You can email him
at jamessaft@jamessaft.com and find more columns at blogs.reuters.com/james-saft)

(Editing by James Dalgleish)

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