European Central Bank (ECB) officials made a splash in monetary policy circles this week by announcing new measures to battle deflation within the eurozone countries.
The move to negative interest rates on deposits has gained the most attention from commentators. Perhaps equally as significant is the announcement of a new €400 billion credit line to eurozone banks, a program that the ECB believes will help encourage small business lending. While this new lending may help, the reality is that monetary policy will not solve the fundamental structural and competitiveness problems of the eurozone countries.
New lending from the ECB, dubbed the Targeted Long-Term Refinancing Operation (TLTRO), is really the continuation of a previous LTRO financing program—but with a twist. Meant to improve lending to businesses, or the “real economy,” the TLTROs are supposed to help siphon demand away from government sovereign debt and mortgage-based assets, two areas where prices have risen in recent months. As ECB president Mario Draghi put it, this money is “not to be spent on sovereigns and on sectors that are already experiencing or are just coming out of a bubbly-ish situation.”
These “targeted” funds are therefore meant to boost private-sector lending, which has shrunk each month since mid-2012. A bump in private-sector lending is believed to be particularly vital to the eurozone’s southern periphery, where nearly a quarter of the workforce is unemployed.
While this scheme is sure to pump money into banks, liquidity is only half of the problem. The other half is competitiveness in the eurozone, particularly its periphery. Morgan Stanley estimates that the periphery—including Greece, Ireland, Italy, Portugal, and Spain—will receive nearly 40 percent of the €400 billion lending line. But this will be of marginal value unless these countries can become competitive enough to put this money to good use.
The prospects for reform certainly aren’t promising. Since 2008, the periphery has done much worse at regaining the competitiveness it lost before and during the crisis. According to the Index of Economic Freedom, co-published by The Heritage Foundation and The Wall Street Journal, since 2008, the countries in Europe’s periphery have seen their levels of economic freedom fall nearly one-half of 1 percent faster per year than the countries in the eurozone core.
Furthermore, foreign direct investment (FDI) has fallen in the periphery since the crisis began. FDI inflows in Greece, Spain, and Italy have all shrunk well below pre-crisis levels, indicating that the problem is bigger than financing, as healthier foreign banks are uninterested in investing. All of these problems are in part the result of falling business and labor freedom. Reforms to regulatory regimes and rigid labor markets and wage structures will be vital to regaining competitiveness.
Draghi can offer all the money he wants to banks, but without solid fundamentals, lending will be anemic. Monetary policy is too blunt of an instrument for these structural problems. Instead, the periphery countries should embrace reform and economic freedom.