Sunday, September 7, 2014

Europe's real problem is unemployment

Post war Europe has been hardly hit by the global crisis. It has affected the heart of its system: the European monetary system. The US financial crisis - which was essentially a banking crisis - has spread its effects all over the world and the European economies were not immune to it. This has resulted in massive wealth and job losses. Now there are worrying signs of deflation and no country is immune from winds of recession. even germany saw a drop of its GDP. 

 However, the eurozone crisis lasts  too because of inherent mistakes in fiscal and monetary policies. For the so-called 'peripheral' countries, the fiscal compact means a perpetual stagnation of their economies. They are all highly indebted, with a ratio debt to GDP close or above 100%, which means that they will have to cut massively their debt ratio putting these countries in an unsustainable situation both economically and socially.

Draghi's speech at Jackson Hole is a promising start. Everyone should read the beginning :

"No one in society remains untouched by a situation of high unemployment. For the unemployed themselves, it is often a tragedy which has lasting effects on their lifetime income. For those in work, it raises job insecurity and undermines social cohesion. For governments, it weighs on public finances and harms election prospects. And unemployment is at the heart of the macro dynamics that shape short- and medium-term inflation, meaning it also affects central banks. Indeed, even when there are no risks to price stability, but unemployment is high and social cohesion at threat, pressure on the central bank to respond invariably increases".

Look at the diverging trends in Europe and the US, leaving aside the different characteristics of labour markets in both geographical areas.

As he explained how the crisis rolled on, he stressed the relationship between financial instability and unemployment. Since 2011, the sovereign debt crisis induces diverging trends within the euro area, with the bulk of job losses in countries most affected.  

Hence, austerity policies brought more unemployed but did not restore confidence. The ECB did it with the famous ' whatever it takes speech' : without disbursing a single euro, ten year bonds soared alleviating the stress on bond market and easing access to finance on international markets. 

In conclusion, " the way back to higher employment, in other words, is a policy mix that combines monetary, fiscal and structural measures at the union level and at the national level. (...) The long-term cohesion of the euro area depends on each country in the union achieving a sustainably high level of employment. And given the very high costs if the cohesion of the union is threatened, all countries should have an interest in achieving this".

Now Europe will enter a new phase. The ECB has cut its interest rate at a level close to zero. This will be followed by an asset back securities (ABS) purchase plan on a large scale to revive lending to the real economy. As expected, this will face strong resistance from the German government and the Bundesbank which will appeal to the Court of Karlsruhe.

Beyond the rhetoric on compliance with fiscal rules, there is now growing awareness about the need to bring an end to eurozone orthodoxy. However, expansionary monetary policies are just a palliative to reduce deflation risks. As L.Summers put it, the excess of savings is responsible for a situation of 'secular stagnation' which justifies negative (real) interest rates and an increase of public spending. 

In his speech at the European parliament, the incoming European Commission President, Jean-Claude Juncker, has proposed a €300 billion public-private investment programme to help incentivise private investment in the EU economy. But this will require bold action from member States to support this EU wide initiative.

It is the time for unconventional policies, not  business as usual ones. The debate on flexibility on fiscal rules may result in sterile discussions while the true question is to  launch a  New  Deal based on an ambitious investment plan and less taxes on labour, especially the low income groups to promote economic recovery and job creation in all European economies. .