Commentary. The central banks are providing massive liquidity. So why isn’t the economy expanding? Obviously, the real problem is endogenous, and it calls our macroeconomic fundamentals into question.

Draghi’s ‘bazooka’ and the Keynesian trap

In the era of fiat money (as legal tender, not covered by gold reserves or other assets), creating money—out of nothing—doesn’t cost anything. The will to do so is enough.

Accordingly, faced with a European economy that is stagnant, with inflation stuck at very low numbers (around 1%), Draghi has seen fit to pull out the big guns.

There will be another round of purchases of government bonds worth €20 billion per month, without any time limit. For banks, it’s a breath of fresh air: fresh money that helps lighten the burden of the bonds they already hold. But it’s also a guarantee for governments, who will benefit from lower costs for their own debt servicing.

But what about the real economy? That is where things get complicated.

The first program of purchases, launched in March 2015 (and which lasted until the end of 2018), has resulted in an injection of liquidity into the system worth over €1 trillion—a deluge of cash.

The bottom-line result for the economy, however, was less than meager. We know this from the estimates brought forward to justify the new program, which is due to start as early as next November. Think about it: if after an injection of €1 trillion we are still stuck at the starting point, something has clearly gone wrong. And it’s not enough to wave this away by invoking the tariff war and the slowdown in world trade.

These factors can only provide a partial explanation. Obviously, the real problem is endogenous, and it calls our macroeconomic fundamentals into question.

As the basis of the ECB’s choice, as confirmed by the maintenance of negative interest rates on deposits (which means that banks, instead of making a profit, have to pay to keep their money parked at the ECB), there is the idea that economic recovery requires a greater propensity on the part of the banks to offer credit.

Accordingly, more liquidity is provided (the plan also provides for a temporal extension of soft loans for banks), together with a disincentive to keep the money stored away in the coffers at the Eurotower.

Where is the error here?

It lies in neglecting the problems arising from an aggregate demand that remains too weak. This is the Keynesian trap: there is plenty of water, but when you lead the horse to it, it doesn’t want to drink. If wages are too low, if unemployment is high, if the inequalities are increasing, if public investment is languishing, the go-to solution is merely to flood the banks with more cash.

It has now been empirically proven: expansionary monetary policies which are not accompanied by fiscal policies working in the same direction are unable to solve the economic problems triggered by a crisis, or by a situation of prolonged stagnation.

We are again faced with the issue of the unsustainability of the philosophy of “rigor” which lies at the basis of European budget rules. In recent days, speaking at the Ambrosetti Forum in Cernobbio, Luis de Guindos, the Vice-President of the ECB, said that “countries with fiscal space should increase their public investment.” And what about those without such “space”? In hindsight, this was an unfortunate involuntary admission. It would be more appropriate to reflect not only on relaxing the Stability Pact (it seems that the issue is finally on the table with the new Commission), but also on different ways of channeling the central bank’s money, to support investment policies and to place the goal of full (and good) employment front and center.

To sum up: what we need is politics. Simply relying on Draghi (or his successor) to “take care of it” is no longer acceptable, given the limits—which are objective ones—of a monetary policy completely independent from democratic representation, detached from the policy action and vision of governments. Only coordination between monetary authorities and budgetary authorities will be able to lead to a turnaround.

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