Against the background of lackluster global demand, economic growth in Europe has weakened again. In the eurozone, a third recession in less than seven years is a distinct possibility. Yet economic policy looks powerless. On the monetary side, although the European Central Bank (ECB) may still embark on a genuine quantitative easing, such action is unlikely to deliver a major boost because the benchmark 10-years government bond rates already only yield 1 per cent. On the budgetary side, fiscal space is scarce and the European discipline framework further reduces the leeway for action. Moreover, those governments that could embark on a stimulus are reluctant to renege on their domestic promises to balance the budget in the near term. Overall, there is some room for a monetary and fiscal boost, but it is unlikely to suffice to address the risks of a triple-dip.
Alternatives must therefore be considered. The most popular among European policymakers is structural reform. Since reforms, the reasoning goes, are needed to address high unemployment and slow productivity growth, they should be enacted without delay. Their swift and comprehensive implementation would help to revive growth. While the premise is undisputable, however, the conclusion is largely flawed. Reforms, especially of the labor market, often hurt growth for several quarters before they start supporting it. In normal times, such short-term effects can be offset by monetary accommodation, but this is precisely what cannot be done in the current situation. Furthermore, many structural reforms result in efficiency gains that lower inflation, which is normally good but undesirable when year-on-year price increases are already perilously close to zero.
There are admittedly a few structural reforms that result in higher growth, higher inflation or both. Simplifying administrative procedures is hardly harmful. Longer shop opening hours improve the service to consumers and create jobs, but they do not lower prices. Reforms that improve company access to finance increase investment and employment but do not give rise to adverse short-term effects. Pension reforms that lead people to work longer improve their lifetime income and to the extent that employees actually expect to have a job, lead them to consume more. As argued by the ECB's Benoit Coeuré in a recent speech, the same applies to reforms that improve future productivity and thereby raise expected incomes. So some reforms do good both in the long and in the short run. But the list is not long enough to ensure that even their comprehensive implementation would suffice to address growth weakness.