Today, the 12th of September 2019 the governing council of the European Central Bank (ECB) will meet for the last time with Mario Draghi at the helm. It may just be his most important meeting ever.
Mario Draghi took over the leadership of the ECB at a very precarious time. Europe was in the grip of a financial crisis. Banks balance sheets were stuffed with government bonds which were priced for a European Union break-up. Populism across Europe was on a rise and hardly any politician was courageous enough to push through desperate needed reforms. The northern states didn’t want to share the debt burden racked up by the spendthrift southern cousins (even though they benefitted from the relatively weak Euro). Instead, austerity was the default policy, and Germany was leading the pact. This obviously did little to revive the economy. Step in Mario Draghi.
From the start of his term he made it very clear that his priority was to defend the Euro, and by implication the Euro area. He famously said that “he would do whatever he can” to defend it. To the horror of the German government, Draghi did start a quantitative easing program, which essentially meant that the ECB would buy government bonds, up to 33% of the issuance. This pushed the long-term interest rates down, freeing up clogged banks balance sheets and spurred them to lend out again. The economies started to recover, and the normally muted German property market experienced a boom, fueled by cheap funding. Now, at the end of his term, Mr Draghi is faced with another crucial challenge, and the outcome would probably shape his legacy.
European economies have mostly recovered from the Global Financial Crisis of 2008 and the European finical crisis thereafter. Eastern European countries have been doing particularly well. Unemployment figures are at all-time lows or getting there. But it seems that the upswing has turned now, not only in Europe but globally. The manufacturing sector in Germany is essentially in a recession and growth in industrial output across Europe is waning. Exports are affected by the trade wars between China and the US.
As signs of a looming recession are becoming clearer, something needs to be done. Just what? Super Mario, as mr Draghi is affectingly known among the investment bankers, can either commit to pull out the big guns and kickstart the quantitative easing program again. Alternatively, he could do nothing, since many of the northern Bonds are trading at negative interest rates, and the Mediterranean equivalent are also trading at record lows.
Go big or do nothing – that is Mr Draghi’s dilemma.
He is not alone facing this challenge. The Chinese central bank has just loosened reserve requirements of banks, because their economy is slowing quicker than expected. Japan and South Korea have their ongoing spat, causing strain on their economies. Even the USA seems to show the first cracks. Even though retail sales and some service sectors are booming, the underlying sectors are struggling. Manufacturing is sluggish, impacted by higher costs and the China–US trade war. The Fed already started to cut rates, although it is debatable if it was due to the relentless political pressure of the Donald, or if it was because of economic growth concerns.
As I wrote in an article some time ago: “the time will become known as one where central bankers did too much, and politicians too little”. Central banks mandates differ from country to country; they are always broadly around two themes; 1) keeping price stability and 2) encouraging economic growth leading to lower unemployment rates.
The reality though is that they are only truly effective servicing the first need, less so addressing the second. There is only so much they can do to drive economic growth. Not so for governments. They have the power to lower taxes, educate their population, keep them safe, keep them healthy and uphold the rule of law. They have far greater powers to encourage new investments.
It is now time for politicians to be bold and courageous and implement reforms that will make their labor market more efficient. They must embrace progress in technological innovation which makes their economies more competitive. Politicians should look at cutting taxes and encourage more businesses to start up. They should stop fighting egocentric spats, stop blaming history and others and stop making unrealistic populist promises. Mr Draghi has done well, but there is only so much a Central bank can do to encourage economic growth. It is time for politicians to take their responsibility seriously.