EU easing under ‘Draghinomics’ a pipedream
Despite the boost he has given the euro zone in recent years, the ECB president has yet to enact full-blown monetary easing or structural reform
Investors continue to underestimate the determination of Mario Draghi, the president of the European Central Bank (ECB), to help shore up the euro zone's depressed economy.
In July 2012, when financial markets feared that Europe's single-currency area might break apart, Draghi promised to do "whatever it takes to preserve the euro", which immediately resulted in a sharp fall in the bond yields of Spain and Italy as investors believed the ECB was willing to stand behind the debts of the euro zone's vulnerable southern European members.
Last week, Draghi surprised markets again by announcing a further cut in the ECB's already negative deposit rate and pledging to buy hundreds of billions of euros of asset-backed securities and covered bonds in a desperate attempt to ward off the threat of Japanese-style deflation in the euro zone.
Once again, the effect on markets was palpable, with the euro falling below US$1.30 (and now standing at US$1.28) and yields on the two-year bonds of several euro-zone countries, including France and Austria, dipping into negative territory.
Draghi is conceding that the ECB is unable to remedy the underlying ills of the euro zone
Investors are clearly impressed. There is even talk of an important shift in economic policy in the euro zone.
Nouriel Roubini, the renowned economist, claims Draghi is taking a leaf out of the book of Japanese prime minister Shinzo Abe, whose radical economic reform programme, known as "Abenomics", is based on the "three arrows" of aggressive monetary easing, fiscal flexibility and structural reforms.
Draghi, in a speech at the Jackson Hole meeting of central bankers last month, said the euro zone's stringent fiscal rules should be rethought and budgetary policy ought to play a stronger role in supporting economic demand in the bloc.
He also stressed the importance - as he always does - of meaningful product and labour market reforms to raise the bloc's long-term growth rate and boost competitiveness.
Does this mean "Draghinomics" is about to take root in the euro zone?
No.
For starters, there are increasing doubts about whether "Abenomics" is even working in Japan, particularly after the sharp contraction of the economy in the second quarter and the fact that wages are not keeping pace with the rise in inflation.
In Europe, there are several reasons to be deeply sceptical about a meaningful change in policy and, just as importantly, about the ability of the ECB to solve the underlying problems of the euro zone - as opposed to simply buoying financial markets.
First, Draghi's plea for more fiscal flexibility was over-interpreted by investors.
At his monthly press conference on September 4, Draghi stressed that the euro zone's much-criticised stability and growth pact, which compels its members to keep their budget deficits under 3 per cent of gross domestic product even during downturns, was an "anchor of confidence" and euro-zone countries should not "unravel the progress made with fiscal consolidation".
Germany, moreover, has been quick to denounce any suggestion that fiscal policy in the euro zone should be eased.
Second, the ECB's latest burst of monetary stimulus falls short of the full-blown quantitative easing which has been undertaken by the United States Federal Reserve and the Bank of Japan.
Third, and most important, the mere fact that Draghi is trying to rally support behind a policy mix that includes fiscal flexibility and structural reforms throws the limits of monetary policy in the euro zone into sharp relief.
Draghi is, to all intents and purposes, conceding that the ECB is unable to remedy the underlying ills of the euro zone: a lack of demand and a dearth of structural reforms, particularly in growth-starved France and Italy where the prospects for meaningful reforms remain bleak.
This should set alarm bells ringing among traders and investors.
The ECB's ability to maintain confidence in the economically depressed bloc is increasingly at risk.
Forget about "Draghinomics". The issue now is whether markets begin to lose faith in the one institution that has been responsible for the dramatic improvement in sentiment towards Europe.
