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How to climb a mountain with both hands tied

Pisani-Ferry, J. (2014) “How to climb a mountain with both hands tied“, VoxEU Organisation, 07 Νοεμβρίου.


A triple-dip recession in the Eurozone is now a distinct possibility. This column argues that additional monetary stimulus is unlikely to be effective, that the scope for further fiscal stimulus is limited, and that some structural reforms may actually hurt growth in the short run by adding to disinflationary pressures in a liquidity trap. The author advocates using tax incentives and tighter regulations to encourage firms to replace environmentally inefficient capital.

Against the background of lacklustre global demand, economic growth in Europe has weakened again. In the Eurozone, a third recession in less than seven years is a distinct possibility. Yet economic policy looks powerless. On the monetary side, although the ECB may still embark on a genuine programme of quantitative easing, such action is unlikely to deliver a major boost because the benchmark 10-year government bonds already yield just 1%. On the budgetary side, fiscal space is scarce and the European discipline framework further reduces the leeway for action; moreover, those governments that could embark on a stimulus programme are reluctant to renege on their domestic promises to balance the budget in the near term. Overall, there is some room for a monetary and fiscal boost, but it is unlikely to suffice to address the risks of a triple-dip recession.

The effect of structural reforms when demand is weak

Alternatives must therefore be considered. The most popular one among European policymakers is structural reform. Since reforms, the reasoning goes, are needed to address high unemployment and slow productivity growth, they should be enacted without delay; their swift and comprehensive implementation would help to revive growth. The premise is indisputable, but the conclusion is largely flawed. Reforms, especially of the labour market, often hurt growth for several quarters before they start supporting it. In normal times, such short-term effects can be offset by monetary accommodation, but this is precisely what cannot be done in the current situation. Furthermore, many structural reforms result in efficiency gains that reduce inflation, which is normally good, but undesirable when year-on-year price increases are already perilously close to zero.



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