How growth has fallen into a trap and what Europe must do

Inflation has been the bogeyman of economic policy planners around the globe for the past quarter century. A reasonable stance, if we consider the devastating effects of stagflation in the second half of the 1970s. This experience made a rational monetary policy the new «golden rule.» Achieving, and then maintaining, low inflation growth rates was, correctly, seen as the surest way to eliminate the market distortions suffered by all economies. It was also the safest method of dealing with the abrupt, often arbitrary, changes in currency exchange rates, which distorted every national economy’s production efforts, reduced the effectiveness of international investments and scared governments. The anti-inflationary policy was also an effective weapon for the protection of incomes and, especially, profits in an increasingly globalized economy. There is no doubt that an economy free of inflationary pressure helps businesses plan their course more effectively, protects the value of property and allows the application of basic rules of fiscal stability. By this principle, inflation in the European Union has fallen from 18 percent in 1980 to 2.2 percent, according to the latest figures. During the same period, the second big goal of economic policy planners was to put their countries’ finances on a healthier footing. Subsidizing the economy through increasing budget deficits fed inflation and accumulated public debt. This is why EU countries agreed on the Stability Pact, to defend the prestige and stability of the new common currency. Irrespective of ideological leanings, governments embraced anti-inflationary measures and fiscal discipline. They left monetary policy to their strong and independent central banks and committed themselves to achieving difficult deficit and debt targets. This policy mix ought, logically, to be effective protection for those economies. Developments in the past few months show that things were not so simple. First, monetary and fiscal policies were not applied concurrently. This is as true of Greece as it is of most other countries. In the USA, the Reagan-Volcker duo’s lax fiscal and tight monetary policy in the 1980s was followed by the Clinton-Greenspan emphasis on debt reduction in the 1990s. Europe generally lagged behind in its reforms, but this allowed it to coordinate monetary and fiscal policies better. On the other hand, while the USA was leading the technology race, helped by its more flexible economy and society, Europe was saddled with a big, deficient and deficit-producing public sector. As a result, huge amounts of capital left Europe for the USA. Morgan Stanley economist Steven Roach estimates that the USA accounts for 64 percent of global growth since 1995, a far higher proportion than the USA’s relative economic weight. Now that the American locomotive is losing its dynamism, Europe is literally dragging its feet. In Germany especially, with inflation and growth at nearly zero, price collapse is a real danger. Europe must immediately adopt aggressive growth measures to escape the impasse.