Press rumours are speculating about the creation of a wider rift between the head of the ECB, Mario Draghi, and Mr.Weidmann, the formal Merkel advisor currently head of the Bundesbank. Whatever the specific motives of the alleged breakdown in their relationship, this personal issue has wider ECB and pan European implications. Simply put, France, Italy and the other weaker EU countries believe that without fiscal stimulus there is no getting out of this painful and prolonged recession. Draghi has done ‘all he could’ with conventional monetary policy and now, in the absence of fiscal stimulus which is constrained by the EU budget rules (i.e. to stay within 3% limit), is beginning to do, at least in Germany’s view, more than he should.
Renzi and Valls’ point of view is widely known: too much continued austerity is killing the patient. They argue that now that both France and Italy have governments which appear serious on reforming, they should be given the slack to enact countercyclical measures that will result in a widening of budget deficits in the short term, but in a sustained recovery in the medium term.
The problem is Germany has seen all of this before, and from their point of view, they need to see real action on the ground of labour reforms, spending cuts, etc. before agreeing to any more stimulus measures. With regards to the unconventional monetary policy steps that Draghi is beginning to embark upon, the Germans are not happy at all. Rock bottom interest rates, negative in certain instances, are hurting both savers and corporates; the idea of the ECB starting to buy structured products is equally scary to them.
As always, the solution will have to be political. France and Italy will have to do more real action on the ground to nudge Germany to reluctantly agree to fiscal stimulus such as widening budget deficits…most will agree that monetary policy has done all it could in this cycle.