The euro zone economy is in trouble. Growth is slowing and deflation remains a real threat, despite significant policy moves by the European Central Bank (ECB). A bout of turmoil in the financial markets last week reflected these growing fears. While some calm had returned by the weekend, the central issue remains. Europe needs to find a way to promote economic growth. Part of the solution lies in the ECB delivering on its promises. However it is increasingly evident that monetary policy alone is not the answer. Europe's leaders need to do more to get growth moving and a central player here has to be Germany. Last week the official forecast for German economic growth for this year was cut to 1.2 per cent, with growth of just 1.3 per cent anticipated in 2015. Recent economic indicators suggest that even this could be optimistic.
Still, the German government says it will not act to spend more. There is strong support in Germany for balanced budgets and Chancellor Angela Merkel and her senior ministers argue that there is no reason to change direction. Given the risks that Europe is facing, this approach is questionable. With low growth and almost no inflation in the core euro zone economies, there are strong arguments to act. One obvious route is for Germany to increase its infrastructure spending, something which could easily be funded given current rock bottom interest rates. Properly chosen projects would also boost Germany's long term growth potential.
Such a move from Germany could form part of a wider EU plan, which could be agreed at the leaders' summit in December. As part of this, France and Italy might be allowed more latitude on borrowing levels, in return for promises of structural reform. The final part of the jigsaw would be an accelleration of the ECB's bond buying programme, another area where Germany has been reluctant to see action. Other work remains to be done, too, of course, including nursing the euro zone's banking sector back to health. Europe's leaders have tended to act decisively only in the teeth of a crisis. Now, however, they need to recognise the considerable risks of doing nothing.
Ireland's diplomatic approach here is clear. The Government must support action on as many fronts as possible to try to get the euro zone economy growing again. There is a strong intellectual argument for doing so – if a monetary union is to work then, in a crisis, countries that have money need to spend more, to balance the inevitable cuts elsewhere. The calculus for Ireland is different. The Government cannot effectively boost the economy through budgetary action, given the high level of borrowing we now carry. The best option for Ireland is fiscal discipline at home, combined with as much as possible being done to support growth in the main euro zone economies.
