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Facing Reality in the Eurozone

LONDON – European Central Bank President Mario Draghi’s recent speech at the annual gathering of central bankers in Jackson Hole, Wyoming, has excited great interest, but the implication of his remarks is even more startling than many initially recognized. If a eurozone breakup is to be avoided, escaping from continued recession will require increased fiscal deficits financed with ECB money. The only question is how openly that reality will be admitted.

The latest economic data have forced eurozone policymakers to face the severe deflationary risks that have been apparent for at least two years. Inflation is stuck far below the ECB’s 2% annual target, and GDP growth has ground to a halt. Without strong policy action, the eurozone, like Japan since the 1990s, faces a lost decade or two of painfully slow growth.

Until last month, growing concern provoked unconvincing policy proposals. Jens Weidmann provided the novel spectacle of a Bundesbank president calling for higher wages. But wage growth will not occur without policy stimulus.

Draghi sought to talk down the euro exchange rate to improve competitiveness. But Japan and China also want competitive exchange rates to spur export growth, and the eurozone already runs a current-account surplus. The German model of export-led growth cannot work for the eurozone as a whole. Structural reform is certainly needed in some countries to increase long-term growth potential; but the impact of structural reform on short-term growth is often negative.