As the European Union braces itself for more timid economic growth and high unemployment, France and Germany are preparing the ground for their next battle: the value of the euro and the role of the European Central Bank. In its spring forecast, which was released May 5, the European Commission said that growth is becoming broader-based in Europe. The headline numbers seem to confirm this statement; this year, the European Union's economy is expected to grow by 1.6 percent, and the eurozone's by 1.2 percent. But the statistics hide the deep divisions between Europe's core and its periphery.
Germany and its satellite economies (Austria, the Czech Republic, Slovakia) are expected to see modest growth and decreased unemployment over the next two years. But Mediterranean Europe (Spain, Greece, Italy and even France) is forecast to experience low growth and high unemployment. Even if Greece and Spain see minor economic growth his year, unemployment is expected to decrease only marginally, continuing to affect more than a quarter of the active population in either country. A year after the Cypriot bailout, unemployment on the island is expected to keep rising for the foreseeable future.
This explains why Europe is slowly getting ready for the debate over the future of the euro and the European Central Bank. France has repeatedly said that the euro is too strong, which hurts French exports as a result. But Germany rejects any attempts to "politically manipulate" the value of the common currency, as a spokesman for German Chancellor Angela Merkel put it May 5. The German logic is that a strong euro makes energy imports cheaper and that the common currency is almost certainly weaker than the hypothetical value of an exclusively German currency.
A decade and a half after the creation of the euro, Paris and Berlin keep fighting over the same issue. In the 1990s, Germany pushed to create a European Central Bank that only targeted inflation, copying the model of the Bundesbank. The French supported a central bank that would tolerate higher inflation in exchange for lower unemployment. An agreement was ultimately reached, and the Germans got what they wanted. At the time, it seemed a fair deal. After all, the Germans were agreeing to abandon the solid Deutsch mark to enter a currency union with their western neighbor. But as with many other agreements made in the optimistic climate of the 1990s, both parties are now feeling uncomfortable with the status quo.
One of the most notable consequences of the financial crisis is that central banks in major economies became even more important national institutions. The bond-purchasing monetary strategy known as quantitative easing (which in practice means large-scale and long-term money-printing) was key for the economic recovery of the United States and Japan. In the case of the European Central Bank, it took limited purchases of sovereign debt in late 2011 and the promise to do "whatever it takes" to save the euro in mid-2012 to to pacify financial markets. It's largely because of this promise that Ireland and Portugal got to end their bailouts without having to ask for precautionary credit lines from their lenders.
But the European Central Bank operates under a completely different mandate than the U.S. Federal Reserve or the Bank of Japan. While the American and Japanese governments were less reticent to engage in fiscal stimulus, the members of the eurozone were under strong pressure to reduce their deficits through spending cuts and tax hikes -- which led to deeper recessions, higher unemployment and the threat of deflation. The American fiscal deficit reached almost 10 percent of gross domestic product at the height of the financial crisis in 2009 -- at a time when Brussels was pushing EU members to reduce their deficits to 3 percent of GDP.
Ultimately, this is an ideological dispute between those who think growth cannot be restored without structural reforms that reduce the government's role in the economy and those who think that growth should be restored first through government measures while debt, deficits and inflation should be addressed afterwards. This explains why countries in Mediterranean Europe are now pushing for the European Central Bank to do more to boost economic growth. Ideally, these countries would like the European Central Bank to imitate its American and Japanese peers and start purchasing assets. From those countries' point of view, their economies are so weak that it would take a long time to reach dangerous levels of inflation as a result of pumping more euros into the system.
But this creates significant problems. If the European Central Bank were to begin a bond buying program, what assets would it buy and from which countries? Do the EU treaties allow it? Can constitutional courts, for example in Germany, challenge it? Critics of quantitative easing argue that it would do little to improve credit conditions in the periphery, at the same time reducing the pressure on national governments to apply reforms. As the eurozone shows some signs of recovery, the voices against bond purchases will grow louder. As a result, the European Central Bank is likely to explore other options, such as applying negative deposit rates or stopping the absorption of the extra liquidity generated by the bonds it purchased in 2011, before seriously considering quantitative easing.
But countries are not monolithic entities. Some German companies have recently joined their French counterparts in criticizing the strength of the euro, a sign that the debate is also taking place within Germany. In the coming months, Berlin will be under increasing pressure from Paris, Rome and Madrid to agree on some form of intervention by the European Central Bank to weaken the euro. For the first time since the beginning of the crisis, a wider bond-purchasing program by the European Central Bank is no longer a taboo topic in German political circles.
The financial crisis in Europe diverted attention from a deeper issue: The European Union has been pretending it has a financial crisis, when in fact it has a trade crisis, with some countries benefiting from the common currency more than others. Up to this point, the debate in Europe was relatively low-key because nobody wanted to draw too much attention to the issue before the elections for the EU Parliament, which will be held May 22-25. After the elections, the European Union will enter a transitional period, in which the new parliament is constituted and new authorities at the EU Commission are appointed. But in the final quarter of the year, the role of the European Central Bank and what to do with the euro will be at the core of the debate in Europe, even if an actual agreement on what to do remains far off.
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