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University of Liverpool - University News


Viewpoint: Time for fresh thinking to spur economic growth in the Eurozone area

published on January 17 2013
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Professor Costas Milas, Professor of Finance at the University of Liverpool’s Management School

“With Eurozone unemployment hitting a new high, Mario Draghi’s statement that “our mandate is not full employment” is really a problem. In light of below-target inflation prospects, shrinking budget deficits and rising unemployment, rewriting the mandate of the European Central Bank (ECB) is the right step towards spurring economic growth”.

“Initial financial and economic data for 2013 have been mixed. Stock markets are rising, and the cost of insuring against default in the banking sector is falling. Yet, the cost of default is still five times higher than its pre-crisis level. More importantly, Eurozone’s unemployment rate has just hit a new high of 11.8%. The International Monetary Fund (IMF) expects Eurozone growth to register an anaemic 1% in 2013 and rise slightly to 1.5% in 2017. Such economic performance is significantly less than the pre-crisis average growth rate of 2.2%. At the same time, Eurozone inflation, currently at 2.2%, is expected to move well below the 2% target, registering 1.6% in 2013 and 1.7% in 2017. As Eurozone countries continue to push with austerity, the I.M.F. estimates that the bloc’s budget deficit-to-GDP ratio will remain well below the 3% Maastricht threshold, dropping from 2.5% in 2013 to 0.8% in 2017.

“Following the first monthly meeting of the ECB’s Governing Council, Mario Draghi’s statement that “our mandate is not full employment” points to the problem. In light of extremely weak growth, shrinking budget deficits and below-target inflation prospects at least until 2017, this year’s resolution should involve a change in the ECB’s mandate.

“Indeed, eurozone member states should recognise the above reality and respond by rewriting ECB’s mandate. The idea is to target the unemployment rate in addition to an existing inflation rate target of (less but close to) 2%. A possible unemployment rate target could be set at 7.7%, that is, the average unemployment rate in the Eurozone area over the last forty years. Indeed, in the absence of inflation risks at least until 2017, but with the jobless rate set to remain (according to the I.M.F. predictions) above 11% until 2014 (and only revert to 9.5% in 2017), focussing on economic growth will allow the ECB to act powerfully in two ways.

• Commit to the currently near-zero policy rate of 0.75% until unemployment shows strong signs of reverting back to its long-run average.

• Revisit Mario Draghi’s proposal to reduce the cost of sovereign borrowing by buying unlimited quantities of government bonds of the troubled peripheral countries. Worried about its inflationary impact, the proposal, involves sterilized intervention. This keeps the total amount of money into the system constant by buying government bonds of the troubled peripheral countries and, at the same time, selling government bonds of the prosperous North. Nevertheless, in the absence of above-target inflation risks, sterilized intervention, if and when it occurs, is bound to have very limited positive impact on the economy. What the Eurozone really needs is non-sterilized intervention (which would boost the currently weak growth of money) in order to spur economic growth and safeguard against adverse potential shocks. Indeed, who can ignore, let alone measure precisely, the spill-over economic effects of (i) the on-going debate about a potential “Brixit”, (ii) a potential bail-out request by the Spanish government, and (iii) an inconclusive outcome in February’s Italian elections which will bring the bloc’s third economic power into troubled economic waters?”

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