Abenomics, European-style

Two years ago, Mr Shinzo Abe’s election as Japanese Prime Minister led to the advent of Abenomics — a three-part plan to rescue the economy from a treadmill of stagnation and deflation.

Abenomics’ three components, or “arrows”, comprise massive monetary stimulus in the form of quantitative and qualitative easing (QQE), including more credit for the private sector; a short-term fiscal stimulus, followed by consolidation to reduce deficits and make public debt sustainable; as well as structural reforms to strengthen the supply side and potential growth.

It now appears, based on European Central Bank (ECB) president Mario Draghi’s recent speech in Jackson Hole, Wyoming, that the ECB has a similar plan for the eurozone.

The first element of Draghinomics is an acceleration of the structural reforms needed to boost the eurozone’s potential output growth. Progress in such vital reforms has been disappointing, with more effort made in some countries (Spain and Ireland, for example) and less in others (Italy and France, to cite only two).

However, Mr Draghi now recognises the eurozone’s slow, uneven and anaemic recovery reflects not only structural problems, but also cyclical factors that depend more on aggregate demand than on aggregate supply constraints. Thus, measures to increase demand are also necessary.

Here, then, is Draghinomics’ second arrow: To reduce the drag on growth from fiscal consolidation while maintaining lower deficits and greater debt sustainability.

There is some flexibility in how fast the fiscal target can be achieved, especially now that a lot of front-loaded austerity has occurred and markets are less nervous about the sustainability of public debt.

Moreover, while the eurozone periphery may need more consolidation, parts of the core — say, Germany — can pursue a temporary fiscal expansion (lower taxes and more public investment) to stimulate domestic demand and growth. And a eurozone-wide infrastructure-investment programme can boost demand while reducing supply-side bottlenecks.

The third element of Draghinomics,similar to the QQE of Abenomics, will be quantitative and credit easing in the form of purchases of public bonds and measures to boost private-sector credit growth.

Credit easing will start soon with targeted long-term refinancing operations (which provide subsidised liquidity to eurozone banks in exchange for faster growth in lending to the private sector).

When regulatory constraints are overcome, the ECB will also begin purchasing private assets (essentially securitised bundles of banks’ new loans).

THE IMPACT OF QUANTITATIVE EASING

Now, Mr Draghi has signalled that, with the eurozone one or two shocks from deflation, the inflation outlook may soon justify quantitative easing (QE) like that conducted by the United States Federal Reserve, Bank of Japan and Bank of England: Outright large-scale purchases of eurozone members’ sovereign bonds. Indeed, it is likely QE will begin by early next year.

Quantitative and credit easing could affect the outlook for eurozone inflation and growth through several transmission channels. Shorter- and longer-term bond yields in core and periphery countries — as well as spreads in the periphery — may decline further, lowering the cost of capital for public and private sectors.

The value of the euro may fall, boosting competitiveness and net exports. Eurozone stock markets may rise, leading to positive wealth effects. Indeed, as the likelihood of QE has increased over the year, asset prices have moved upwards, as predicted.

These changes in asset prices, together with measures that raise private-sector credit growth, can boost aggregate demand and increase inflation expectations.

One should also not discount the effect on “animal spirits” — consumer, business and investor confidence — that a credible commitment by the ECB to deal with slow growth and low inflation may trigger.

Some more hawkish ECB officials worry QE will lead to moral hazard by weakening governments’ commitment to austerity and structural reforms. However, in a situation of near deflation and near recession, the central bank should do whatever is necessary, regardless of these risks.

Moreover, QE may actually reduce moral hazard. If QE and looser short-term fiscal policies boost demand, growth and employment, governments may be more likely to implement politically painful structural reforms and long-term fiscal consolidation.

Indeed, social and political backlash against austerity and reform is stronger when there is no income or job growth.

Mr Draghi has correctly pointed out that QE would be ineffective, unless governments implement faster supply-side structural reforms and the right balance of short-term fiscal flexibility and medium-term austerity.

In Japan, although QQE and short-term fiscal stimulus have boosted growth and inflation in the short run, slow progress in the third arrow of structural reforms, along with effects of the current fiscal consolidation, are taking a toll on growth.

As in Japan, all three arrows of Draghinomics must be launched to ensure the eurozone gradually returns to competitiveness, growth, job creation and medium-term debt sustainability in the private and public sectors.

By the end of the year, it is to be hoped, the ECB will start to do its part by implementing quantitative and credit easing. PROJECT SYNDICATE

ABOUT THE AUTHOR:

Nouriel Roubini is chairman of Roubini Global Economics and a professor at New York University’s Stern School of Business.