The theatrical resignation threat by Manuel Valls, the French prime minister, combined with deep European anxiety about deflation, suggest that the euro crisis may be coming back. But a crisis is often an opportunity, and this is the hope now beginning to excite markets in the eurozone.
Investors and business leaders are asking themselves three questions: Will European governments and the ECB recognise the unexpected weakness of the eurozone as an opportunity to change course? If they do, will they know how to grasp it? Will they be allowed to do what is necessary by the true economic sovereign of Europe, German Angela Merkel?
First, the opportunity. Europe still has a chance to save itself from a Japanese-style lost decade of stagnation and deflation. And this may be a last chance, because a lost decade in Europe could produce some very un-Japanese social rebellions and political upheavals. Europe lacks Japan’s social consensus, national unity and financial cohesion. It is far from clear that Europe could survive 10 years of recession without the eurozone breaking up and even perhaps the EU.
Second, what must Europe do to save itself from stagnation and disintegration? The obvious answer is to follow something similar to the “three arrows” programme popularised (though not genuinely implemented) by Japan’s PM, Shinzo Abe. Abe’s “three arrows” were: aggressive monetary stimulus; fiscal easing requiring suspension of deficit and debt targets, and structural reforms to correct long-term weaknesses in both supply and demand.
Judging by ECB Chairman Mario Draghi’s speech at Jackson Hole, all three of these policies are becoming feasible. The central bank is hinting at more growth-oriented monetary policy, the European Commission seems willing to interpret its fiscal rules more flexibly, and national governments are promising to undertake more structural reforms.
The problem is that all these hints and promises are hedged with too many conditions, uncertainties and caveats. Even if the ECB decides to experiment with US, British and Japanese-style QE, its record suggests that it will probably do too little, too late—just enough to prevent a collapse of the euro but not enough to pull the European economy out of its slump.
The prospects for fiscal and structural reforms are more discouraging, judging by the political upheaval in France. President Francois Hollande responded to his PM’s resignation threat by sacking Arnaud Montebourg, the left-wing economy minister, along with several allies. But Montebourg was calling for budget flexibility and fiscal reflation, policies very