The European Central Bank recently left interest rates unchanged at its most recent rate policy communication. This was on the heels of the prior cut in rates where Europe is experimenting with a negative interest rate environment. The press conference in recent days showed a Mario Draghi that sounded defeated about the ECB’s ability to fight a Eurozone recession alone. Now Mario Draghi, who is President of the European Central Bank, delivered a speech at the Brookings Institution in Washington that sounded even more negative.
Investors should know that Mario Draghi’s comments only helped to aid the selling wave seen on Thursday when the Dow Jones Industrial Average was down by more than 300 points.
In Thursday’s delivery, Draghi stressed an urgent need to raise potential output in the euro area through reforms. He even referred back to an open letter which was written back in 1933 by economist John Maynard Keynes — to President Franklin D. Roosevelt — on reform and recovery in the US.
Draghi’s take is that without reform in the euro area, there can be no recovery. He said,
“Put simply, I cannot see any way out of the crisis unless we create more confidence in the future potential of our economies… given demographic trends, raising structural growth will have to take place primarily through productivity.”
On monetary policy, Draghi indicated that the ECB is now transitioning from a monetary policy framework (predominantly founded on passive provision of central bank credit) to a more active and controlled management of the balance sheet. The goal — to lift inflation from its low levels.
What Draghi did not delve deeply into was the notion of deflation. Still he promised to lift inflation up from its excessively low level. He said that this inflation trend could include changing the size and/or composition of unconventional policies. His views included the notion that fiscal policy can still support demand by altering the composition of the budget, particularly by simultaneously cutting distortionary taxes and unproductive expenditure.
The big issue here is Draghi’s comment that “the euro zone fiscal policy is by and large neutral for growth” and that the “modest euro zone recovery is already losing momentum.” Draghi’s target is for inflation to return back up to 2%, but gradually and by 2016 or 2017.
When you have central bankers throwing their hands up calling for outside reforms, couple with governments that are more inclined to lean toward protecting social benefits rather than business, what does it signal? Draghi is sounding more and more like a man caught in a shootout who ran out of ammo — and who just keeps yelling to convince others that he may still have some ammo.