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The Eurozone’s Minsky Conundrum

November 13, 2015

The Eurozone’s Minsky Conundrum

BRUSSELS – Stubbornly low inflation has the European Central Bank worried. But its response – essentially just more quantitative easing – could backfire, exacerbating imbalances and generating serious financial instability.

As it stands, the headline consumer price index in the eurozone hovers around zero, and even core inflation remains below 1% – too far for comfort from the ECB’s target of around 2%. While a new round of weakness in global commodity prices earlier this year contributed to these figures, it does not explain the weakness in longer-term inflation expectations, which have improved little since March, when the ECB started its massive €60 billion ($66.3 billion) per month bond-buying program.

But instead of rethinking its strategy, the ECB is considering doubling down: buying even more bonds and lowering its benchmark interest rate even further into negative territory. This would be a serious mistake.

Easier credit conditions and lower interest rates are supposed to boost growth by stimulating investment and consumption demand. But in the core of the eurozone – countries like Germany and the Netherlands – credit has been plentiful, and interest rates have been close to zero for some time, so there was never much chance that bond purchases would have a significant impact there. And, indeed, the European Commission’s most recent economic forecast shows that spending in the core countries has not increased as a result of the ECB’s policies; Germany’s external surplus is actually increasing.

Of course, in the highly indebted peripheral countries, there was room for interest rates to fall and for credit supply to grow – and they have, leading governments and households to increase their spending. While the asymmetrical impact of the ECB’s policy is appropriate in principle (because unemployment is much higher in the periphery), the reality is that a recovery supported by the least solvent economies is not sustainable.

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