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3/12/16

The euro zone is marching along nicely, with ECB leading the way - by ERIC REGULY

euro-zone hanging in there
How many blows can the euro zone take before it collapses into a great, bleeding sovereign heap? A lot, apparently.

Every few years, indeed, every few months, the euro zone is written off as a failed experiment. Every monetary union since the Roman empire has blown up or simply faded away and the euro zone will be no exception, its detractors insist; just give it time. Nineteen countries running at 19 different speeds, with jobless rates ranging from 5 per cent to 25 per cent can’t possibly stick together.

The European Central Bank’s response on Thursday to waning inflation and growth seemed to prove the detractors right. Almost eight years after the 2008 financial crisis, the euro zone remains such an indolent economic sloth that the ECB actually invented a way to pay the banks to make loans to businesses and consumers. The novel scheme was part of yet another stimulus package, one that knocked interest rates to zero and boosted the ECB’s quantitative easing bond purchases to €80-billion ($118-billion) a month, that was flung on top of piles of stale stimulus packages that basically didn’t work.

The ECB’s new and seemingly desperate attempt to juice up the economy was an overreaction, although not massively so, and the euro zone is not as utterly hopeless as the headlines suggest. The euro zone may look like it’s dancing drunkenly through a field of land mines, never more than a stumble away from destruction. But the dance is not the suicide run it seems to be.

Take the Sentix Euro Break-up index. The index shows how investors rate the probability of a breakup of the euro zone (such as Greece hitting the road) within 12 months. The latest reading was 19.9 per cent, which looks pretty high. In comparison to previous peaks, it’s not. In 2012, at the height of the euro zone crisis, the index hit 70 per cent. Last summer, when Greece again taunted the euro zone with its exodus, the index reached 50 per cent. From the investors’ point of view, the breakup scare, while far from absent, is now relatively low.

More evidence that the euro zone is not doomed comes from the fairly strong growth rates in some countries and the rocket-like performance in a few. Ireland, which sued for a bailout in 2010, is taking on Celtic Tiger status again. Its gross domestic product grew a stunning 9.2 per cent, year-over-year, in the last three months of 2015, outranking India and China. Spain, the euro zone’s fourth-largest economy, grew 3.2 per cent in 2015. It, too, had been a basket case during the crisis.

Portugal, another bailout victim, eked out growth of 1.5 per cent last year. Greece, now grinding through its third bailout, remains the lone euro zone country in recession (Finland entered a technical recession last year, defined as two consecutive quarters of contraction, but is expected to bounce out soon). Italy is expanding painfully slowly, but managed to report good news on Friday: Industrial production in January jumped 1.9 per cent, month-on-month.

Over all, euro zone growth is not great, but it’s improving. The ECB expects growth of 1.4 per cent this year and 1.7 per cent in 2017. No crisis here. So what made the ECB president haul out the bazooka this week? His stimulus package was more aggressive than economists had expected.

In a word, inflation. Or more precisely, the lack thereof. In February, inflation turned negative, at minus 0.2 per cent compared with a 0.3-per-cent rise in January. Mr. Draghi wants headline inflation at close to, but not beyond, 2 per cent. But the figure seems arbitrary. There is no compelling rationale to argue that inflation of, say, 1.5 per cent or 2.5 per cent is inherently evil, and falling inflation rates are not always terrible to behold. 

In this case, they are largely owing to the collapse in energy and commodity prices in the last year and a half, which have given consumers extra spending power. If energy and seasonal food prices are excluded, “core” inflation actually rose by 0.7 per cent in February.

Inflation, in other words, hasn’t disappeared. The ECB expects more or less flat inflation this year, rising to 1.3 per cent in 2017 and 1.6 per cent in 2018, and those figures could prove conservative if oil prices, which have climbed by almost 50 per cent since January, keep rising. Mr. Draghi’s big, fat stimulus package seems more like an insurance policy than a panic response to a new crisis. There is no new crisis.

To be sure, the euro zone and the wider European Union face serious problems, from Britain’s potential departure from the EU to the refugee crisis. But Britain probably will vote to stay put and, even if it goes, the euro zone’s integrity would not be compromised since Britain doesn’t use the euro. The refugee crisis has not killed the EU’s passport-free zone, known as Schengen, in spite of endless predictions that it would. The loony populist parties of the far right and the far left have yet to form governments (Greece’s far left Syriza party wasn’t loony enough to ditch the euro). There is no war in the EU countries.

Growth and inflation are not dead. On the whole, the euro zone is in much better shape than it was three or four years ago, even two years ago. The new stimulus package is bound keep things moving in the right direction. For that, you can thank the ECB.

Read more: The euro zone is marching along nicely, with ECB leading the way - The Globe and Mail

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