In an article published in the Frankfurter Allgemeine Zeitung, Isabel Schnabel, Member of the Executive Board of the ECB states that governments taking more debt now should not be a concern, and would strengthen the central bank independence in the future.
She claims that “the decisive fiscal policy intervention in the coronavirus (COVID-19) crisis strengthens the effectiveness of monetary policy and mitigates the long-term costs of the pandemic. With targeted, forward-looking investment, not least under the umbrella of the EU Recovery Fund, governments can foster sustainable growth, increase long-term competitiveness and facilitate the necessary reduction of the debt ratio once the crisis has been overcome”.
The problem of Ms Schnabel’s article is that it ignores the facts and bets the future of the central bank independence on a rigorous, profitable and successful level of government investment that has never happened and is even more less likely to occur now.
Ms Schnabel should be, in fact, warning about the enormous risk of malinvestment and excessive debt that may arise from the European Recovery Fund implementation and the massive deficit spending arising throughout the Eurozone. Why? Because she has the empirical evidence of the failure to achieve the virtuous growth and debt reduction she expects with the examples of the Growth and Jobs Plan of 2009, the Juncker plan and the enormous rise in deficit spending between 2009 and 2011 among many European nations. Once growth recovered, three things were evident:
Ms Schnabel knows that the experience of previous crises shows us that no, in times of weakness governments should not decide to supplant the private sector. Governments do not have better or more information than the private sector on where and how to invest and have all the incentives to malinvest and overspend because the ECB continues to support by buying sovereign bonds and cutting rates. The evidence of rising debt, poor productivity and higher unemployment than its peers of the eurozone should be enough of a warning sign, and the example of Japan should serve as a red flag as well. Ms Schnable knows that the elevated levels of debt to GDP incurred by most eurozone countries will not be reduced to pre-pandemic levels, even less to sustainable levels, with constant public deficit spending promoted by monetary policy and with calls to questionable “investments”. Ms Schnable may ask herself one question: If all those massive “investments” that some eurozone governments are announcing are profitable, productive and will promote long-term growth and jobs, why none of them had been implemented in the 2014-2019 period despite low rates, high liquidity and the Juncker plan to support? Because the vast majority of what most eurozone countries will include in the “investment” recovery plan are not productive, profitable or growth-oriented projects.
Ms Schnable should know that many eurozone countries like Spain have relied on monetary policy to disguise structural challenges, and that monetary policy has gone from being a tool to buy time to implement structural reforms to a tool to avoid them. Ms Schnable should also know that the euro is not the world reserve currency and that replicating the Federal Reserve’s policy does not make governments spend wisely and productively. The ECB balance sheet is now 57% of GDP and negative rates have been there for years, and the result has been disappointing growth in the good times and a larger crisis in the bad times. The rising role of governments in the economy is not a coincidence. It is one of the leading causes of the eurozone’s weakness, when governments already consume more than 40% of annual GDP.
The evidence of the past shows us that governments do not create jobs, growth or competitiveness. An IMF paper analysing government spending plans concluded that “the effect of government consumption is very small on impact, with estimates clustered close to zero… which raises questions as to the usefulness of discretionary fiscal policy for short-run stabilization purposes” (Ilzetki et al, 2011). The eurozone has showed that negligible positive impact for years.
Unconventional monetary policy was not implemented because governments spent too little, but because governments spent too much, and could not finance themselves without central bank quantitative easing and asset purchases.
The ECB will not strengthen its independence with large deficit spending and massive debt from member states. It will be even more dependent on disguising the insolvency of countries once, when Covid-19 stops being an excuse, debt and government spending will continue to rise.
Daniel Lacalle is one the most influential economists in the world. He is Chief Economist at Tressis SV, Fund Manager at Adriza International Opportunities, Member of the advisory board of the Rafael del Pino foundation, Commissioner of the Community of Madrid in London, President of Instituto Mises Hispano and Professor at IE Business School, London School of Economics, IEB and UNED. Mr. Lacalle has presented and given keynote speeches at the most prestigious forums globally including the Federal Reserve in Houston, the Heritage Foundation in Washington, London School of Economics, Funds Society Forum in Miami, World Economic Forum, Forecast Summit in Peru, Mining Show in Dubai, Our Crowd in Jerusalem, Nordea Investor Summit in Oslo, and many others. Mr Lacalle has more than 24 years of experience in the energy and finance sectors, including experience in North Africa, Latin America and the Middle East. He is currently a fund manager overseeing equities, bonds and commodities. He was voted Top 3 Generalist and Number 1 Pan-European Buyside Individual in Oil & Gas in Thomson Reuters’ Extel Survey in 2011, the leading survey among companies and financial institutions. He is also author of the best-selling books: “Life In The Financial Markets” (Wiley, 2014), translated to Portuguese and Spanish ; “The Energy World Is Flat” (Wiley, 2014, with Diego Parrilla), translated to Portuguese and Chinese ; “Escape from the Central Bank Trap” (2017, BEP), translated to Spanish. Mr Lacalle also contributes at CNBC, World Economic Forum, Epoch Times, Mises Institute, Hedgeye, Zero Hedge, Focus Economics, Seeking Alpha, El Español, The Commentator, and The Wall Street Journal. He holds a PhD in Economics, CIIA financial analyst title, with a post graduate degree in IESE and a master’s degree in economic investigation (UCV).