CAMBRIDGE – Although the European Central Bank has launched a larger-than-expected program of quantitative easing (QE), even its advocates fear that it may not be enough to boost real incomes, reduce unemployment, and lower governments’ debt-to-GDP ratios. They are right to be afraid.
But first the good news: anticipation of QE has already accelerated the decline of the euro’s international value. The weaker euro will stimulate eurozone countries’ exports – roughly half of which go to external markets – and thus will raise eurozone GDP. The euro’s depreciation will also raise import prices and therefore the overall rate of inflation, moving the eurozone further away from deflation.
Unfortunately, that may not be enough. The success of QE in the United States reflected initial conditions that were very different from what we now see in Europe. Indeed, eurozone countries should not relax their reform efforts on the assumption that ECB bond purchases will solve their problems. But even if these countries cannot overcome the political barriers to implementing structural changes to labor and product markets that could improve productivity and competitiveness, they can enact policies that can increase aggregate demand.
To be sure, the major eurozone countries’ large national debts preclude using traditional Keynesian policies – increased spending or reduced taxes – to raise demand through increased budget deficits. But eurozone governments can change the structure of taxes in ways that stimulate private spending without reducing net revenue or increasing fiscal deficits.