ECB has to breathe new life into the economy

The ECB can drag the European economy out of the mire through large-scale purchases of bonds issued by the European Investment Bank. The capital can be used to fund new infrastructure projects in the euro countries.

This idea is being put forward by Harald Benink of the University of Tilburg and Wim Boonstra, Head of the Economic Research Department at Rabobank. The economists launched their idea in Dutch Newspaper Het Financieele Dagblad last week in a collective response to the proposal by Mario Draghi, president of the European Central Bank, to start buying government bonds.
Wim Boonstra: ‘The rate of inflation in Europe has fallen to less than zero in recent months and prices in the eurozone will fall further in the months to come. Draghi says that inflation in the eurozone needs to rise towards 2%. Generally, we agree with this, although we do not think that the ECB has yet found the most effective way to achieve it.’

The Dutch economists fear that the ECB’s proposal to purchase government bonds issued by eurozone countries will fail to achieve its aims. ‘Simply buying government bonds will only create new market bubbles and will not create higher growth, although that is what is needed. Various leading international organisations, including the International Monetary Fund and the OECD recommend that the eurozone urgently needs a boost to growth..’

Benink and Boonstra suggest that a sum of up to 1,000 billion would be made available that could then be invested in large-scale public projects that could strengthen the growth potential of the European economy. ‘The projects could include bridges, transport infrastructure, sustainable energy, electricity networks, ICT networks and high-level education and research. Most eurozone countries have little potential for making such public investments due to the poor state of their government finances. Germany, and to a certain extent the Netherlands as well, do have room in their budgets, but appear to have little enthusiasm for boosting investment at the moment.’

European Commission Chairman Jean-Claude Juncker has already made a proposal for setting up a fund under the auspices of the EIB. ‘This plan would deliver up to 300 billion and is an important step in the right direction, but we think it is not enough. Furthermore, the Juncker plan would not really reduce the risk of deflation in the eurozone. This will only be achieved by a substantial growth impulse funded by monetary policy.’

According to Boonstra, the proposal whereby the ECB would buy bonds issued by the EIB and the proceeds would be used to fund European infrastructure projects has three clear advantages. ‘Firstly, a boost to investment of around €1,000 billion would encourage consumption and reduce unemployment. Simply the announcement of such a substantial boost to the economy would positively affect consumer and business confidence. Furthermore, focused investment in European infrastructure would strengthen the supply side of the economy. This would be beneficial for competitiveness and the potential for growth in Europe in the longer term. Lastly, we think that such a sizeable monetary boost would contribute to somewhat higher inflation. This would enable us to ward off the danger of real deflation and the economic stagnation that this would lead to.’