Even though several central banks took actions this week to boost growth, the likelihood is that global growth will remain sluggish for some time. The ECB, the Bank of England and the People’s Bank of China either cut rates or injected liquidity. With interest rates at record lows and excess reserves very high, it is unlikely that these moves, in themselves, will have a meaningful impact. The ECB cut its deposit rate to zero; this is the rate they pay on the excess reserves of banks held on deposit at the central bank. The move is intended to encourage European banks to put their money to work—either through lending to the private sector or lending to the government (in the form of increased purchases of government securities). But with banks under pressure to increase capital and economies in the doldrums, the effect of the rate cut is more symbolic than actual. Banks accept negligible returns when they park funds with the ECB because they value the security of the central bank. This won’t change significantly, even with a deposit rate of zero. No doubt market tensions will return as the European crisis is far from resolved.
The Eurozone is the epicentre of global uncertainties and the ECB’s modest actions will do little to assuage these concerns.
Hopefully, the door is still open for additional non-standard methods to address the crisis of confidence, such as easier collateral rules and more long-term refinancing operations, as well as the revival of the ECB bond-buying program. Once again, the ECB is running the risk of being overtaken by events, conducting a reactive, rather than proactive policy.
However, it is clear there is only so much that monetary policy can do, particularly for the weaker economies.
Additional energetic efforts to strengthen competitiveness and the recovery of public finances are essential. Nevertheless, it would take enormous cultural change and, potentially, massive transfers of money from the rich countries of Europe—mainly Germany—to begin to mitigate the longer-term inequalities. Germany knows how difficult and expensive this can be all too well, having been engaged in a similar effort for the past 22 years with the unification of the economies of East and West Germany. The former West Germans were taxed significantly to boost industry and living standards in the East. German taxpayers continue to foot the bill for the multi-decade bailout with a so-called “Solidaritätszuschlag” or solidarity tax on income of 5.5%. Estimates vary, but the widely accepted cost figure thus far is about €1.5 trillion, and the West continues to support the East with transfer payments of about €100 billion a year. The currency union came too fast. In 1990, one deutsche mark was worth about four ostmarks, but the currency union set a 1:1 exchange rate, since the alternative would have meant massive migration. Overvaluing the currency, however, meant that East German industry collapsed as wages became uncompetitive, leading to massive unemployment. (Sound familiar?) This effect was compounded by mass migration of mostly young, talented people, the very people needed most to rebuild and populate the eastern economy. Many who left to work or study were also female. The hoards of unemployed, loveless young men left behind have caused social problems like a low birth rate and right-wing extremism. The gap between East and West remains wide and money alone is not enough.
Four decades of communism had a huge cultural impact. Officially, neither unemployment nor private property existed in East Germany prior to 1990. The state subsidized rent, heating and childcare. Many struggled to adapt to the capitalist system, despite Germany’s generous social welfare system. But Germans were willing to make sacrifices for an economic and political union. The common bonds of brotherhood between East and West were strong. No such ties exist between Germans and Greeks, Spaniards, Italians or the Portuguese. Germany does not want to underwrite the Eurozone, yet it is ultimately a necessary, though not sufficient, condition for the Eurozone’s survival. After more than two decades of costly transfers and huge infrastructure investments, the unemployment rate in the former East Germany is over 11% compared to 6% in the former West. The gap in per capita income has narrowed significantly since 1991, but much of that is owing to the migration westward of job seekers. Productivity growth in the East is still poor.
Bottom Line: Germany wants to see substantial market reforms in the peripheral countries before they agree to eurobonds or additional German subsidization. Among these reforms are those imposed in East Germany: the privatization of state-controlled enterprises; more flexible labour markets where layoffs are possible; special economic zones; and the creation of a dual educational system offering vocational training as well as academic studies. Germany will not easily succumb to pressures to underwrite this unification. Meanwhile, markets and the global economy will be held hostage.