EU NEEDS BOTH MONETARY AND FISCAL STIMULUS

Europe is finally going to get its own massive monetary stimulus. But that doesn't mean it can save the region's economy. A flurry of media reports suggest Mario Draghi, president of the European Central Bank, will unveil a program today to buy bonds worth 50 billion euros a month, starting in March. That could inject more than one trillion euros ($1.2 trillion) into the eurozone economy by the end of 2016.

The Quantitative Easing (QE) programme alone, however, won't be enough and there is the risk of a  triple-dip recession. The problem in Europe is aggregate demand  and what is needed is both monetary and fiscal stimulus e.g. increased government spending in infrastructure thereby creating more jobs and higher tax cuts thereby increasing the purchasing power of people. With QE, the ECB will be buying more time for European governments to press ahead with economic reforms. Growth is unlikely to pick up any time soon and it might take years for Europe to reach its inflation target of close to 2%.

Without reforms in France and Italy, and fiscal stimulus by national governments, QE will not turn Europe's economy around.

The major international financial institutions are unanimously demanding active state intervention. However, the final effect of fiscal stimulus may be ambiguous in those situations where countries suffer from structural deficiencies. And most of the EU member states indeed do so. The analysis of the experience of European expansionary fiscal policies point out that success (that is, accelerated economic growth) comes about in countries which preferred tax reduction rather than the increase of public spending. Furthermore, a negative output gap seemed to be an important condition for success. Nevertheless, in the current economic situation, where private demand has declined substantially, countries may have no other option than to fuel aggregate demand by boosting public spending. Governments should concentrate on extra spending however, in the sphere of so-called core functions (such as education or R&D) on the one hand and the recapitalisation of the banking sector on the other. By pursuing such an approach, additional public money can contribute to the increase of potential GDP in the long run, beyond the short-term demand effect. The EU, unfortunately, has reached the current crisis with a trend-GDP expanding only at a decelerated pace and a positive output gap in the majority of the countries. Sadly enough, this has happened mostly in those countries where fiscal discipline already melted away years ago. Neither the earlier experiences, nor the current prospects are therefore too encouraging.

Furthermore, it is worth underlining that in times of crisis

• Crisis management cannot culminate in a prisoner’s dilemma-type situation, where the gain of one party is the loss of the others. The EU needs to coordinate its actions amongst the Member States and should refrain from adopting protective measures which would endanger political and economic integration.

• Not all member states can adopt expansionary fiscal measures. The degree of fiscal room for manoeuvre differs significantly from one country to another in the EU.

• Extra budgetary spending must only be temporary and cannot threaten economic sustainability in the long run. The problem of an ageing population can be disregarded only for the relatively short period of crisis management; in the long term, however, attention should be directed again towards the consolidation of public finances.