The euro’s obituaries were premature

By Buttonwood

FIVE years ago, Mario Draghi, head of the European Central Bank, pledged to do “whatever it takes” to save the euro. At the time, many people were predicting that the euro zone would break up. But Mr Draghi pulled off the trick; no countries have left the single currency. Borrowing costs have come down and even Greece has been able to tap the markets.

Keeping the euro together may have been the aim of the game, but was it worth it? As M&G, the fund management group, points out, the record has been mixed. Economic growth has rebounded to a respectable 1.5% year-on-year. This is not stellar but it is hard for the euro zone to grow rapidly when its population is ageing; the IMF suggests a greater proportion of older workers may weigh on productivity growth.

Of course, the euro zone could get more of the current workforce into the job market; unemployment remains too high. Economists debate whether this is down to a lack of demand (caused by overly tight fiscal policy) or by structural barriers such as an inflexible labour market (which creates insiders, who are hard to dismiss, and outsiders, whom employers are unwilling to hire). Neither issue has anything to do with the ECB. The bank could be criticised for not getting inflation up to 2%. On the other hand, if you had told people 10 years ago that the ECB’s balance sheet would be more than €4trn, that it would have bought government bonds and imposed negative interest rates, few would have believed you.

The whole exercise has been a remarkable illustration of the power of a central bank. Does this prove the case of believers in modern monetary theory, who argue that there is virtually no limit to a government’s resources, provided that it has the support of an independent central bank? It seems a bit early to say that. First, in the early years of the crisis, commercial banks were tending to shrink their balance sheets and cut lending; central banks thus acted to stave off a Great Depression-style shrinking of the money supply. The policy consequences for governments might be rather different if commercial banks were indulging in a credit spree. Second, an individual central bank that rapidly expanded its balance sheet might face the problem of a currency decline, as international investors became less willing to hold it. But in the last nine years, all the big central banks have been expanding their balance sheets, so investors have had no “weakling” to pick on. That might not be the case going forward, as America starts to tighten policy.

Voters in Greece or Italy may not feel that Mr Draghi has been that successful, given the damage done to the former economy and the stagnation in the latter. What cannot be known is the counterfactual. Had Greece left the euro, citizens would have probably seen their bank deposits devalued, and inflation and interest rates soar. Argentina’s trials in the early years of the 21st century are a case in point. There will not be many statues put up to Mr Draghi but he deserves a fair deal of credit.