Mario Draghi, the President of the European Central Bank, which sets monetary policy for the nineteen countries that use the common currency, the Euro, seems to be at odds with Chancellor Angela Merkel. This rift is an important one, since Germany is the largest economy in Europe, and it has been the largest benefactor in all past bail-outs within the Euro.
Governments traditionally have two primary financial tools to use, either in toning-back an over heated economy, or jump-starting a stagnant one. Unfortunately, the various members of the Eurozone have relinquished one of those tools—Monetary Policy—the management of interest rates and the amount of money in circulation (the Money Supply). Fiscal Policy, taxing and spending, for countries in the Euro, however, is still managed by the individual governments. And that’s the problem! The two financial tools are not coordinated.
The ECB has recently slashed its key lending rate to zero, and is even charging banks to park excess funds at the central bank. The bank’s immediate concern is raising the Inflation rate, with a goal near two percent. Dropping interest rates down to nothing, according to Draghi. was meant to stimulate the economy and increase inflation. When Inflation turns negative—“Deflation” —that generally causes the economy to stall, and then collapse. So, lower interest rates seem to be counterproductive, at least in this situation, in trying to stimulate the economy.
Germany runs a tight ship economically, and it expects the other countries in the Eurozone to do the same. Chancellor Merkel’s political concern is that the ECB’s very low rates means that German savings accounts are paying next to nothing. Here’s where the other financial tool would be extremely helpful.
Think of monetary and fiscal policy as being like the two peddles on a car, where the driver can alternate between using the break and the gas pedals. Lowering the base lending rate, especially when inflation is almost nothing, is just plain dumb! Lower rates would just discourage consumers from buying things now, and businesses from expanding their operation.
Its important to remember that fiscal policy tools, which remains under the control of the various sovereign nations, might be a good alternative in stimulating the economy in a low inflation environment. Deficit spending—such as repairing roads, bridges, railroads and seaports—would put people to work. Employed people pay taxes and spend money. And that increase in consumer spending will, in turn, create even more jobs and greater tax revenue. That also decreases the demand on the Social Safety Net.
The lack of coordination of the two major financial tools—fiscal and monetary policy—is the greatest shortfall in the Euro. So far, however, the global recovery from the Great Recession—although quite slowly—began in early 20009; however, Europe just hasn’t caught on.