Draghinomics: a new economic policy of EU and lessons for Vietnam

Draghinomics: A New Economic Policy of EU and Lessons for Vietnam VU THANH TUNG University of Finance and Banking - billvutung@yahoo.com Abstract During recent years, Europe has faced

Draghinomics: A New Economic Policy of EU

and Lessons for Vietnam

VU THANH TUNG

University of Finance and Banking - billvutung@yahoo.com

Abstract

During recent years, Europe has faced many economic problems EU (European Union), its member countries, and ECB (European Central Bank) have tried all their best to find solutions to overcome this hard period The President of the ECB, Mario Draghi, has built ‘‘Targeted Longer-term Refinancing Operation’’ (TLTRO), which is considered as one of the most important economic plans in the modern world in order to recover Europe economy This event has affected not only EU but also the world, including Vietnam By studying content of Draghinomics, using qualitative method to analyze successes and limits of the theory, this paper draws some experienced lessons for Vietnam when our country is on the way of restructuring the economy

Keywords: Draghinomics; EU economy; Vietnam

Europe is a large continent, and EU is one of the biggest economic zone in the world EU’s GDP was 22% of global GDP (16.2 trillion euros) in 2015 In the list of top ten countries whose GDP are highest in the world, EU has Italia, England, France, and Germany Therefore, EU economy’s health greatly affects the whole world After a long way of development, Europe growth has been slower gradually That GDP of Europe accounted for 32% of total the world GDP in 1980 was just a nice memory Beginning in 2012, EU’s recession has lasted until now This has been caused by the US financial crisis 2009 and internal problems of EU such as government debts, high unemployment,

markets down, conflicts between members…Recently, Brexit (Britain exits EU) has made Europe’s

situation much worse

On July 8, 2016 IMF (International Monetary Fund) forecast GDP of the Eurozone (containing 19

members) would only reach 1.6% this year, compared with 1.7% it made in the previous time, and GDP in 2017 would fell to 1.4% General Director of IMF, Christine Lagarde (2014), has warned that the European crisis would have been out of control of ECB If six member countries of EU in financial difficulties do not get enough support, EU will collapse and peace in Europe will disappear Thomas Barnett (2015), the leading strategist of the famous consultancy firm Wikistrat in the US, judged that

“the US, which is considered to be one of the most important pillars of globalization, is entering a hard period and focusing on local industries And now, Europe, another key pillar of the world, would have exploded.”

Not only EU but also all Europe have been trying to find possible solutions to “break the back of the Beast.” As the President of ECB, Mister Mario Draghi (2012), promised to do “whatever it takes”

to save the euro and the EU economy The man, called “Super Mario of Europe” by the magazine Libération (France) for his success in persuading the ECB Board of Directors to demolish a “taboo”— recorded in the Europe agreements, not to fund the budget deficit by printing money, has actually done what he had said He now uses Draghinomic to make EU restored to its normal life If the Eastern world has Abenomics, the economy theory of the Japan Minister Shinzo Abe, the Western world is also welcoming Draghinomics

This paper uses qualitative method to explain basic content of Draghinomics By listing, comparing, and contrasting the secondary data, the paper points out what are successes and limits

of this well-known theory Although this economic policy is rather new in the world and we should have been waiting for its results patiently, the author hopes to draw some good lessons for the Vietnam’s economy

2 Overview on Draghinomics

2.1 Origin of the nickname “Draghinomics”

Draghinomics means the economic theory of Mister Mario Draghi The nickname was registered

a birth by the illustrious economist Nouriel Roubini, the professor of New York University's Stern School of Business and the chairman of Roubini Global Economics, an economic consultancy firm Actually, Draghinomics represents “Targeted Longer-term Refinancing Operation” plan

The term ‘‘Name-nomics’’ appeared in 1980s when American called the economic theory of the

US President Ronald Reagan “Reaganomics” Like Abenomics, the economic revival program of Japanese, TLTRO is the initial sign of an economic stimulus program for the Eurozone It plays a key role to promote the necessary restructuring for the potential growth of Eurozone, and to get this zone over the danger of falling into deflation TLTRO is appreciated the shocking solution of ECB directing to European banks

2.2 Background of Draghinomics

Economic stagnation

European banks were engaging in an inevitable and rapid deleveraging process that had been an expected repercussion of the credit bubble Now that deleveraging is a bank-specific initiative, the ECB cannot influence its scale It was in this context that ECB did a complete assessment of banks’ state of health before making them directly supervised Since the summer of 2013, the banks that fall under ECB’s live supervision have strengthened their balance sheets by almost 203 billion euros The crisis of banking sector and enormous government debts degenerated into growth slump 4 years ago

so that it threatened 3 biggest economies of Eurozone, Germany, France, and Italia The “domino effect” came true in EU Germany is on the edge of regression, whereas France is coming to the deadlock, and Italia growth is nearly the same as 15 years before

In 2014, growth in the Eurozone stalled in the second quarter, following four quarters of sluggish recovery from a crisis over high government debt Unemployment remains at 11.5% after increasing for a long time

Figure 1 Unemployment has increased in 2008-2013

Source: Eurostat (2014)

Eurozone has severely low inflation, which can slow growth for many years There was a sudden decline in exports and industrial activities in Germany, the dominant Eurozone economy Markets have gone down more and more Both internal problems and the global market turmoil made investors in the European economy worry about its falling into recession The Stoxx 50 index of top Eurozone stocks fell down by about 5.7% over the past three months Exchange-traded funds such

as the Vanguard FTSE Europe ETF (VGK), the iShares MSCI EMU Index Fund (EZU), the iShares MSCI Germany Index Fund (EWG), the iShares MSCI EAFE ETF (EFA), and the iShares MSCI Italy Index Fund (EWI) fluttered to track European equities

Figure 2 Eurozone growth in 2004-2015

Source: Euro Stat (2014)

Recently, investors in European markets has recognized the spreads for Italian and Spanish ten-year government bonds widen relative to German bonds This widening showed faltering investor confidence in the future of not only leading economies in EU but also other European countries

On October 16 2014 Italy’s leading financial index fell by 1.2%, strengthening the market’s belief that Europe were weakening Worsening economic data, an extravagant debt-to-gross domestic product ratio, a burgeoning unemployment rate, and a very low inflation rate are some of the key factors that have instilled negative sentiments in investors in ETFs (exchange-traded funds) that track European equities

Figure 3 Europe is weakening

Source: NYSE Arca (2014)

Eurozone yields have been still lower than 3% from pre-recession peak in early 2008 Therefore,

it is not surprising that inflationary pressures are absent That market belief in the inflation target of the Eurozone in the next 5 years had been eroded caused financial markets to fear that inveterate disease Although Eurozone might have overcome the worst period of the debt crisis, but lending to small and medium enterprises (SMEs) are still weak That is why this zone cannot get a break in economic growth

Huge government debts

The Eurozone crisis, in particular, resulted in debt crises in several EU member states, and many countries had the collapse of financial institutions, increasing unemployment rates, and high government debts According to EU rules, member countries that use the Euro are not allowed to run annual deficits of more than 3% of GDP; Spain, Italy, and France all ran deficits above the ceiling

Figure 4 EU Government debt has increased in 2002-2013

Source: Eurostat (2014)

Notably, Greece’s financial collapse required IMF and ECB bailout packages of $147 billion and

$173 billion in 2010 and 2012 respectively However, Eurozone’s growth continues to stagnate due to high unemployment and deflation GDP of the second quarter in 2014 remained sluggish The third-quarter forecast had nothing positive due to the Ukraine crisis

Figure 5 Real GDP of EU in 2002-2013

Source: Eurostat (2014)

Deflation and low inflation

Core inflation was 0.8% month in January 2014, which was only marginally better than the recorded low level of 0.7% at the end of 2013 In some countries, inflation was low, but it was more worrying than in others whose deflation pushed real interest rates go up It caused concerns that Eurozone would fall into deflation Along with increases in government borrowing, rising labor costs and trade deficits have resulted in economic distress for EU In order to keep the debt burden not to

go up and repay debts, banks, households and governments must cut their huge expenditure; lenders and consumers also cut spending at the expense of investor confidence

ECB’s responsibility

Economic situation of the Eurozone stagnation cannot blame ECB’s harsh financial policies as well

as the fragility of the banking system, both of which have crippled growth But ECB must be responsible for the ominous low rate of inflation, which was 0.4% and much lower than the ECB’s 2% target ECB has dealt with banks’ problems slowly The inspections and monitoring which had been carried out in 2104 brought the opportunity of clearing credit records and recapitalize weak banks, but they proved quite late This delay led to the credit crunch so that banks must curtail lending

To promote credit growth, ECB injected over 1000 billion Euros into the banking system in 2011 and 2012 in order to deal with the liquidity crisis when the debt crisis was at its peak Instead of using this large amount of cash to lend businesses, commercial banks tended to deposit money at ECB When the crisis got over, banks had to repay LTRO borrowings Now banks owe ECB only 435 billion euros, or 45% of the initial LTRO loans Interest rates in the money market increased, thereby raising Euro and the pressure of deflation To prevent this situation from happening again, at the meeting

in June 2014, ECB lowered interest rates on deposits by negative If commercial banks want to deposit

at ECB, they must pay fees

Some reasons of crisis

The root cause of financial diseases in Europe is told to be three issues which are closely related together: (i) EU leaders do not have enough courage to promote structural reforms strongly to raise economic growth; (ii) European voters and residents have not really seen the urgent need to reform radically; and (iii) So tight monetary and fiscal policy strangled growth, and made reform much more difficult to be done

The Eurozone has been plagued by near-zero growth, high unemployment, and deflation in the wake of the Great Recession If monetary union did not bring nothing but stagnation, unemployment, and deflation, eventually some other Brexit will come true again The situation will be very difficult without a push from the EU leaders The existence of these problems prompted Super Mario to implement his economic program in 2014

2.3 Contents of Draghinomics

In his plan, Mister Mario Draghi has set forth a three-part strategy including:

Figure 6 Three steps of Draghinomics

On September 18, 2014 ECB officially started to run Targeted Longer-term Refinancing Operation whose initial capital was 400 billion euros Its target is to promote economic recovery across the continent after years of crisis Mister Mario Draghi (2014) expressed his confidence that TLTRO and ECB’s recent policies would help Eurozone economy ‘”re-stand on its feet.”

Draghi’s three-part economic program focuses on aggressive structural reforms, fiscal policy, and massive monetary policy through quantitative and credit easing They may be called Draghi’s three-pillared strategy or his three arrows policy (similar to Abnenomics)

Figure 7 Three arrows of Draghinomics

Monetary stimulus from the ECB

Added government spending from countries that can afford it

Pro-business reforms to cut bureaucracy and make economies more productive

EU economy ’s recovery

Structural

reforms

Fiscal Stimulus

Massive monetary policy

Three Arrows of Draghinomics

Structural reforms

While monetary and fiscal policy plan to promote short-term growth, structural reforms aim to create long-term growth on the supply side The first core principle of Draghinomics is the adoption

of rapid structural reforms to improve output growth across the Eurozone Draghi has stressed the importance of economic reforms to drive recovery In a recent speech at the Brookings Institution in Washington on October 9, 2014 the ECB Chief argued, “Without reform, there can be no recovery.”

He meant reforms were the only way to lift growth rates because problems of EU tended to be more structural than cyclical, relating to the structure of economy as opposed to business cycles

ECB can only directly control monetary policies, so EU members must implement structural reforms in order to stimulate economic activity Labor markets are a key area of focus for reforms Like Abenomics of Japan, Eurozone is creating more flexible labor markets and encouraging women

to join in labor force There is scope to raise labor participation rates in Europe’s case However, given the unfavorable demographic trends in most European economies, structural growth will have

to rely on productivity Increasing productivity will also help match aggregate demand boosted by monetary policy

Fiscal stimulus

The second principle, fiscal policy, aims to maintain debt sustainability and long-term growth Draghi gives prominence to positive fiscal policy through the use of tax cuts rather than increased spending Actually, expansionary policy may increase income and the propensity to consume The economic multiplier effect suggests that an injection of extra income with greater use of aggregate fiscal policy will lead to improved spending

There are two key conditions for the fiscal policy to be effective in its stabilization role First, EU governments must have fiscal space lest budgetary constraints restrict the implementation of certain policies Second, the fiscal policy must have ensured the sustainability of public finances

Figure 8 Two keys of fiscal policy in Draghinomics

Structural fiscal

consolidation

Framework for fiscal governance

Draghinomics's Fiscal Policy Measures

that fiscal policy can cooperate with monetary policy in improving aggregate demand Governments always have the option of regenerating their fiscal space by expanding source of revenue For those not having fiscal space, fiscal policy can still support demand by altering the composition of the budget, in particular, by cutting distortionary taxes and unproductive expenditure Moreover, structural reforms in Eurozone can help the governments achieve higher potential output, and raise future government revenues

Monetary policy

Since European banks have lowered their loan-to-deposit ratios and restructured their capital, they have not been in a position to pass on low interest rates to customers Thus, Draghinomics used the monetary policy to act on two keys: Carry out an expansionary policy to combat conditions of low inflation and substantial slack in the economy; fix the transmission process of monetary policy

so that this way actually reaches firms and households The third arrow of Draghinomics relates to quantitative and credit easing which are the forms of buying government bonds and promoting credit growth for the private sector

Figure 9 Measuring ECB’s monetary policy

Under quantitative easing (QE), ECB will buy large amounts of sovereign bonds to increase the amount of money in financial markets QE, which creates money for buying financial assets without central banks printing, and other unconventional monetary policies have been implemented to boost economic activities ECB is even open to the option of quantitative easing, if need be Inflation outlook could have been one of the key reasons for making QE that was similar to what FED (Federal Reserve System) , BOJ (the Bank of Japan) or BOE (Bank of England) had done before—buying government bonds on a large scale

Since June 2014, ECB has launched the TLRTO, which has a built-in incentive mechanism to

encourage loans to companies ECB was ready to offer cheap long-term loans to banks if they lend the money on to firms TLTRO is a program that allows banks to borrow funds at low rediscounted interest rate, only 0.05% until 2018, so as to provide credit to the economy If banks cannot reach the object lending for investment or consumption, they will have to pay back the amount borrowed

in 2016 With TLTRO, ECB aims to lend 1 trillion euros over the next 3 years in order to make inflation reach target levels and support the economy by directing the flows of credit into businesses This huge program has been implemented into 2 phases: In the first one, for the period between

Rate cut and

open market

purchases

Forward Guidance

Draghinomics's Monetary Policy Measures