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Not the election

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Today, on the day of the UK’s crucial general election – which effectively is a second referendum on whether or not the country should leave the European Union – it would be all too easy to forget that it’s also an important day in the life of the EU, the day when Christine Lagarde chairs her first meeting of the European Central Bank’s governing council.

Lagarde is preparing only the second strategic review in the ECB’s 20 year history. The last one was in 2003 – five years before the Great Crash. What Lagarde does, matters just as much as the UK election result. So far she has appeared to give greater priority to “climate change”, although the climate is not part of the ECB’s stated mission.

Why does it matter what Lagarde says or does?

Because the Eurozone area, 19 countries, is struggling with low growth of 1.8% in 2018, probably 1.1% in 2019, and forecast gross domestic product (GDP) growth of just 1.2% in 2020 and 2021. Meanwhile unemployment remains stubbornly high in the Eurozone and is officially forecast to be above 7% out to 2022. Unlike the US Federal Reserve, the ECB doesn’t have as part of its mission the achievement of maximising sustainable employment; but it is responsible for “maintaining price stability.” That stability is now looking fragile.

The ECB has tried to keep the Eurozone’s economy sputtering along by Quantitative Easing (QE), that wonderful euphemism for printing money. This money has been used mostly to buy government bonds. The QE programme has pumped around €3 trillion into the monetary system.

The ECB however has a limit to how much of a country’s bonds, currently 33%, it can buy. The ECB itself says: “The issuer limit of 33% is a means to safeguard market functioning and price formation as well as to mitigate the risk of the ECB becoming a dominant creditor of euro area governments. To this end, the 33% limit is applied to the universe of eligible assets in the 1 to 30-year range of residual maturity”. A further consideration is that the ECB has to buy government bonds in proportion to each Eurozone country’s contribution to the ECB’s capital. The Netherlands and Germany, the biggest contributor to the ECB, are very close to this 33% limit – the ECB has bought more than 30% of Germany’s bonds.

The ECB can of course make up its own rules, and the 33% bond-buying limit can be raised; it has already done that once, from 25% to 33% in September 2015.

The ECB has lowered interest rates to minus 0.5%, the lowest on record; it has swamped the Eurozone with €3 trillion (and is printing €42 million a month currently); it has used every monetary tool in its kit, and yet economic growth frankly is still weak.

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What can Lagarde do different to kick-start the Eurozone’s economies? Not much, probably. According to a Reuters’ poll more than 90% of economists thought in November this year that she will continue her predecessor’s, Mario Draghi, “dovish policy stance”.

The worry about all this is very simple: how long can the ECB continue using tools that clearly haven’t worked? And what might the consequences be if the Eurozone slips into a recession, with little economic activity to repay all this debt?

Lagarde might try to persuade the 19 member states of the Eurozone to adopt fiscal expansionism, i.e. spending money directly in the economy, by building roads, improving rail infrastructure, more hospitals, more schools, and so on. This is unlikely to persuade Germany, for one; its policy for decades has been tight fiscal conservatism. Those opposed to fiscal splurging may well point to the example of Japan, where the government has announced a $121 billion fiscal stimulus to defeat the country’s chronically slow growth and deflation, with little hope of it working.

So, right at the moment that the UK may well send a symbolic signal that it will, after all this British turmoil, finally leave the EU in 2020 or later – it’s never been part of the Eurozone – the ECB, and its infant, the Euro, are starting to look bereft of new ways of fighting slow economic growth. Confidence in the ECB, in the Euro, could begin to ebb, as various member states think about going their own separate ways.

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