The challenges facing the euro

epa08068255 (L-R) European Central Bank (ECB) President Christine Lagarde, German Chancellor Angela Merkel and EU Commission President Ursula Von der Leyen during the second day of the European Council summit in Brussels, Belgium, 13 December 2019. EU leaders gathered in Brussels on 12 and 13 December to discuss climate change, the EU's long-term budget and external relations, the economic and monetary union and Brexit, among other issues. EPA-EFE/OLIVIER HOSLET

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There has been a change in the guard in Europe. With very little in the way of fanfare, Christine Lagarde replaced Mario Draghi as the head of the European Central Bank. Lagarde had spent the last 8 years as the Managing Director of the International Monetary Fund, in the wake of the financial crises of 2008 and 2011. The role of being at the head of the IMF requires a healthy dose of patience, foresight and diplomacy. Lagarde will be putting those traits to the test as gets comfortable at ECB headquarters in Frankfurt – there is much work to be done.

The European Union is going through a challenging time. Ever since the 2008 financial crisis which hit the United States, the political, economic and social situation in the EU has never fully recovered. European politics has been beset by the rise of the far right, Brexit, economic stagnation, and social discontent with austerity policies which have seen governments rise and fall in the south of the continent, in particular. It is 2019, and soon to be 2020. Many young people have no semblance of what a central bank interest rate rise looks like, or what impact it has on their livelihoods, particularly loans and mortgages. Pensioners lament the low interest rates and the meagre returns they are receiving on their savings. Mario Draghi had succeeded in keeping the euro, one of the greatest experiments of our time, afloat. But he was unsuccessful in convincing euro members like Germany and Netherlands to spend more money to help offset economic and financial weaknesses in countries such as Italy, Spain and Greece. This may be where Madame Lagarde’s biggest challenge lies.

A number of European economists have long warned that given the wide range of initiatives undertaken by the European Central Bank over the past decade, there is very little left that can be done from a monetary policy perspective. European politicians have long been encouraged by the ECB to invest more in infrastructure and have broadly accommodating fiscal policy, which seeks to spur government investment in the economy. This would have a knock on effect for the rest of the euro, generating more economic activity in the hope that it will help to raise the prospects of the more heavily indebted southern European nations. This will be challenging, however. Germany in particular has been resistant to increasing its national spending, at a time in which it has been reducing its national debt, and seeks to have balanced budgets year on year. Without a doubt, Berlin is considered the economic engine within the euro zone, and the EU at large, so unless Germany commits and implements a fiscal policy which allows for more government spending, there can be little improvement in the European economy, and little hope to offset the pain of the Mediterranean countries.

Some might ask, well why is Germany so reluctant to spend more? That would require a long explanation, going into historical dynamics. But to put it in brief terms, Germany has had experiences in the past where it was spending and printing money recklessly, and refuses to be drawn into a situation where it will increase its national debt once again in order to help out fellow eurozone members, even if Berlin is arguably the primary beneficiary of the euro. This will be a battle that many market analysts will be watching closely over the months, and years ahead.

Another item which may seem a bit unusual to be discussing within the context of the ECB’s operations is climate change. Lagarde had made climate a topical issue within the halls of the IMF, and had made sure that her IMF staff kept an eye on developments on the national level to ensure that fiscal and monetary policies were not negatively impacting environmental considerations. She has gone on record, ever since being assigned the ECB President’s job, as saying that climate change is “mission critical”. This would point to her putting some emphasis on the importance of bringing climate change onto the agenda at the ECB, although how, and in what form remains to be seen. The ECB is mandated to be a neutral player in the market, so it cannot look to incentivise the purchase of cleaner, green technology. It is difficult to see how this new green push will factor into the ECB’s policy making going forward, but Christine Lagarde is not one to make idle comments, so we should expect to be hearing more about this in the year ahead.

The euro zone economy is going through a period of slow growth, which is better than no growth at all. The ECB’s mandate is to provide price and inflation stability, although inflation has been stubbornly low for close to a decade now, which has kept prices lower than some in the economy would like. In order for the economy to grow further, euro zone members have to be willing to put their hands in their pockets and spend on areas that are in dire need of investment, not least in things like national infrastructure. There are roads, bridges, and railways across Europe that are in dire need of repair and upgrading. This could be an area in which the ECB and national governments meet halfway. Eventually, these things need to be fixed, for the benefit of those same governments. Some gentle prodding may be needed, but it is necessary in order to prepare the euro for any future economic downturn. The ECB has done more than its fair share over the past decade – now it is up to the governments to do some heavy lifting.

Matthew Bugeja = CiConsulta GeoPolitics Advisor 

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