The Eurozone economy in recent years has faced the problem of permanent deflation. The deflation is occurred as a result of the low levels of overall demand in the economy.
The low levels of global demand in addition to the Eurozone overall demand also characterize the global economy (2019 & Q1 2020). As a result of these inadequate levels of overall demand in the Eurozone are the compression caused by both the prices of products and services and all kinds of profits.
In addition, the insufficient overall demand causes a reduction in total production levels which lead to an increase in unemployment, with the result that the economy to operate in anemic growth rates or recession.
by Thanos S. Chonthrogiannis
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In the first part (Part-I) of this series of analyses with title “The Sustainable Solution for the Eurozone Economy” we will present the ECB’s political and economic efforts so far in order to avoid the prevalence of deflation in the Eurozone, but also the appropriate fiscal strategy for the Eurozone economy.
In the second part (Part-II) we will present the ineffectiveness of the current Eurozone fiscal framework and clearly, we will indicate what are these fiscal policies that must implement in the Eurozone as a whole.
In the third part (Part-III) we will outline how the proposed policies to reduce the government expenditure should be applied to the budgets of the central governments of the Eurozone member countries in order to drastically reduce the taxation in their economies. In addition, we will show the future results of the proposed fiscal framework that will must apply in the Eurozone/EU.
In the fourth and final part (Part IV) of this series of analyses we will mention, and we will indicate the introduction of operational in practice rules to tackle unemployment across the Eurozone/EU as a whole. In addition, we will present the appropriate organizational structure for the fiscal framework proposed by us in the euro area, which has not yet existed in the Eurozone, but also its results.
The ‘ weapons ‘ to date used by the Eurozone through the ECB
The European Central Bank (ECB) in its effort to induce inflationary pressures on the Eurozone economy in order to decompress prices and profits with aim to induce an artificial increase in investment behavior across the Eurozone has used its main “weapons of its arsenal “which are:
1. The policies to intervene in the money supply in the Eurozone economy which includes:
a) Quantitative easing
b) Credit easing
c) ECB interventions in the euro exchange rates with other major world currencies with a view to increasing exports to the Eurozone.
2. The interference policies in the money-pricing that include:
a) The policy of close to zero basic borrowing interest rates to commercial banks; This policy includes also a series of reductions in the euro short term basic borrowing interest rate (overnight) which ECB offers to commercial banks.
b) The negative interest rates on commercial banks deposits which ECB offers to commercial banks
c) ECB’s oral policies as to the no surprises in the international capital markets as regards its intentions to reduce short-term interest rates
Despite the efforts of the ECB, with the implementation of its above policies, the problem of inadequate aggregate demand and deflation remains in the Eurozone and since interest rate levels will must follow the prevailing inflation rate levels, these interest rate levels will have to be at low levels (negative levels) to increase total Eurozone demand levels.
But at zero levels of euro basic borrowing interest rates there will be no increase in total demand.
The orthodox economic thought shows that the ECB should never renounced the only weapon it has to deal with future endogenous and exogenous crises in the Eurozone, by selecting the “abyss” of the negative euro basic borrowing interest rate.
This choice will forcibly push it into the constant printing of money to make attractive investments in the Eurozone, while leaving the Eurozone unprotected.
The increase in liquidity through the reduction of the euro basic borrowing interest rate is not helping, because the yields of government bonds of euro area member countries are at a very low level.
In addition, there has been no real cleaning up of which European banks are viable-profitable and must continue to operate and which are not.
The support for the Eurozone’s banking system with aim to support the real Eurozone economy through the strategy of increasing liquidity and reducing basic borrowing interest rates resembles the decade of 1990’s, where Japan has tried to support its banking system with gigantic injections of liquidity and zero level basic borrowing interest rates policy (1995).
With this strategy it was led to its impasse to stick its interest rates on this same low level from 1995 to the present, leading to the known “lost decades” for the Japanese economy.
This strategy of the Bank of Japan shows us that independently of the degree of aggressive policy that a central bank can implement in the country’s economy (in this case the Central Bank of Japan), this does not mean that it will necessarily cause that degree of inflationary pressures that will cause in their turn an increase in total demand and consumption levels in order to increase the growth rate of the economy.
The appropriate fiscal strategy for the Eurozone economy
In my view, it is a mistake to reduce the Eurozone’s key basic borrowing interest rate to almost zero levels without first having to implement policies in the Eurozone economy to increase the real (disposable) income of citizens, particularly of citizens who belong to low and medium-sized income scale.
In the current era of the globalized economy, this increase in the real (disposable) income of citizens will have to come through the implementation of an equivalent fiscal value measures caused by the simultaneous drastic reduction of direct and indirect taxation in all economies of Eurozone member countries.
The drastic reductions in indirect and direct taxation in the economies of the member states will must come from a reduction in governmental expenditures and, above all, from the reduction in the size of the annual primary government expenditures in the budgets of their central governments.
This increase in the real (disposable) income of Eurozone’s citizens in turn will cause both the increase in total demand and consumption levels and the increase of their savings levels.
In conjunction with the accompanying economic policies that I proposed for guaranteed deposits in the euro area dominion (see, analysis entitled, «How the guaranteed deposits in the EU can help to develop the Eurozone economy» posted at https://liberalglobe.com, 21/12/2018, category: economics) the increase in savings level will be high (either in the form of bank deposits or in the form of private insurance).
A drastic increase in the levels of aggregate demand and consumption by Eurozone citizens by low and middle incomes equally will then support an increased turnover of businesses.
Which in turn will cause an increase in their production levels, which in turn, these companies will create new full-time jobs to absorb the unemployment.
In addition, it will minimize any uncertainty of the business world for the future, which will cause an increase in their investments to cover their increased production levels.
Why should avoid the strategy of low-level basic borrowing interest rates?
Without first having implemented policies to increase the real (disposable) income of citizens with low and medium-sized incomes that are most citizens, policies to reduce the euro basic borrowing interest rate in lows levels are usually operated as financing of stock and capital markets investments respectively, with low borrowing cost in euros.
The low cost of borrowing will be directed to refinancing of private debt, to equity investments and more generally to investments in securities (e.g. shares, government bonds, etc.).
In this case, the aim is to obtain a fast and higher profit return in investment compared to the investments in the real economy of the Eurozone.
Where the investments in the real Eurozone economy may currently contain a higher investment risk and lower corresponding returns due to the low aggregate demand and consumption in the Eurozone and always compared with the yields of investments in transferable securities.
In addition, the cheap euro currency-denominated borrowing will finance non-euro zone investments.
As outside the euro area dominion the returns of the investments in the real economy may be higher than the returns on investment in the real economy of the euro zone member-countries and given that the investment risk in both cases is the same.
Such a strategy would lead to increased demand for the euro currency due to low borrowing costs, making the euro currency more expensive in the long term, without these funds necessarily being directed to the real Eurozone economy to create mainly new full-time jobs.
In the peripheral Euro-area member-countries such as Greece, due to distortions and non-implementation in the act of reforms in the economy and the non-implementation of drastic cuts in the annual primary public sector expenditures of the central government budget, these funds will not be directed to the real economy to reduce unemployment.
But will be used mainly for the re-financing of private and sovereign debt making their future repayment more difficult, given the existence of negative inflation in the Eurozone economy.
In the Euro area member countries such as France, Spain, Portugal, etc., in addition to the public and private debt re-financing, which, due to negative inflation, will become more difficult to repay, it is very likely to have further deviations from the fiscal targets for a general government budget deficit of less than 3% of the GDP in the state budgets of their general governments.
And of course, due to artificial growth in demand policies through increased social benefits.
Slippage of the value of the euro currency (devaluation) in relation to the main world currencies, and especially against the US dollar, favors exports mainly from the Nordic member countries of the Eurozone.
But does not favor the member countries whose economies use the oil as main raw material, because oil costs are priced in U.S. dollars and its price increases since its supply remains stable and demand for oil is increasing.
In addition, a rising value of $ U.S. can increase total demand in the U.S. economy but will create great difficulties both in the economies of China and Latin American countries (e.g. Brazil) and in the Russian economy.
Since together, these economies are at the same time in a state of recession or declining growth, resulting in long-term reductions in global aggregate demand levels.
Significant reductions in global aggregate demand levels would force small and medium-sized enterprises in the euro area, which are the bulk of businesses in its economy, to reassign any pre-planned investment projects.
While reducing at the same time their overall production levels and increasing the unemployment levels in the Eurozone.
In such an unfavorable perspective for global aggregate demand, the only prospect of increasing the total demand for the products and services of Euro area companies will must come internally from their customers/citizens in the Eurozone/EU.
I will must point out that the ECB’s behavior to date is exemplary in its efforts to curb deflation and increase inflationary pressures in the Eurozone while trying to persuade international capital markets and investors.
But in this strangle ECB is left alone to fight for the Eurozone economy.
Its room for manoeuvre and its policies-strategies have already been exhausted and the ECB does not have the proper assistance from the leaderships of the Eurozone member-countries that have left it alone to defend the “hot gates” of the Eurozone economy.
The whole macroeconomic impoundment that prevails in the Eurozone economy can very easily be rectified but in this case are needed a high degree of serious fiscal decisions by all the leaders of the Eurozone and the European Commission.
These fiscal (budgetary) decisions for the whole of the Eurozone in some cases contain high political costs in the short term.
But they will release significant levels of prosperity for all Euro-area citizens, which will, among other things, give great economic and mainly political benefits in the long term.
In the second part of this series of analyses we will clearly indicate what these fiscal policies should be, which should be implemented throughout the Eurozone economy.