The mantra is that once again it is up to the ECB to save the Eurozone. Quantitative easing is the last policy tool available to jumpstart the Eurozone economy. The longer the ECB waits before starting to buy government bonds, the further away will the recovery be. This analysis, however, overestimates the power of monetary policy.
The main challenge currently faced by the Eurozone is a lack of aggregate demand. This is much more important than internal imbalances or lack of competitiveness in the periphery.
At the end of 2013, private consumption in the Eurozone was 2% below its 2007 level while private investment was 20% lower. Producers’ prices have been decreasing for over a year. The only bright spot is the rise of exports by almost 10% since late 2013.
In the US, by contrast, GDP and private consumption are 6–7% above where they were six years ago, and investment too is above its pre-crisis level.
If lack of demand is the problem, then the solution can only be found at the European level. Fiscal policy is bound by the Stability Pact and monetary policy is in the hands of the ECB. Moreover, spillover effects between member states make a coordinated effort to revive aggregate demand much more effective than isolated, country-specific actions.
What can be done to increase aggregate demand in the Eurozone? From a technical point of view, the answer is simple and has few disadvantages.
All countries should enact a large tax cut, say corresponding to 5% of GDP. They should be given several years (say three or four), to reduce the budget deficit created by this tax cut, through a combination of higher growth and lower expenditures. To finance the additional deficits, members states should issue long-term public debt with a maturity of say 30 years. This extra debt should all be bought by the ECB, without any corresponding sterilisation, and the interest on the debt should be returned to the ECB shareholders as seigniorage.
Combining a monetary and a fiscal expansion is key to the success of aggregate demand management, as shown by the recent experience of other advanced countries. Quantitative easing by itself would not do much to revive bank lending and private spending, because credit in Europe flows mostly via banks, rather than financial markets. And fiscal expansion without monetary easing would be almost impossible, because public debt in circulation is already too high in many countries. The