World Economy

Eurozone Afraid of Recession, Deflation

Eurozone Afraid of Recession, DeflationEurozone Afraid of Recession, Deflation

Eurozone is once again facing a serious situation. And this time the immediate danger to the 18-member monetary union is not the stability of the currency or the solvency of any state, but the twin worries of recession and deflation: An economic contraction with a simultaneous drop in prices.

Mario Draghi, President of the European Central Bank (ECB), made his concerns clear to the European finance ministers at their informal meeting in Milan. In the second quarter, the eurozone economy was practically flat. The inflation rate was only 0.3 percent, and unemployment is still far too high, Mario Draghi said.

The central bank, therefore, slashed the key interest rate to virtually zero, he explained. But that means the conventional monetary policy tools of a central bank have been exhausted.

To boost the economy, Draghi plans to provide cheap loans in the coming weeks and months, allowing banks access to low cost, safe money. His hope is that they will finally start lending to businesses again, especially in the crisis-hit southern countries, a Draghi confidant said on the sidelines of the meeting. But there is no guarantee they will.

Hand in Hand

The ECB is now letting the finance ministers know that because it has reached the limits of its financial instruments, it's now their turn to do something.

Draghi put it diplomatically: "Only if structural, fiscal and monetary policies go hand in hand will the euro area see investment return," he warned in Milan. "We will only manage to stimulate investment if structural, fiscal and monetary policies mutually reinforce each other."

The central bank chief expects the finance ministers to provide more money for public investments in their budgets and to create better conditions for business. Since this is not part of the bank's remit, which critics say he has pushed to its extremes, Draghi now expects the ministers to act.

The finance ministers are responding to this warning in very different ways. Italian Finance Minister Pietro Carlo Padoan wants to save less and make more money available for investments. France wants that too, but budgetary discipline would suffer. Furthermore, this could increase the countries' debt burden. Italy and France are already among the eurozone's heavily indebted countries.

EU Budget Commissioner Jyrki Katainen also warned against reckless spending, urging governments to focus on resolving structural problems. "Without real reforms, effectively implemented, we will not have sustainable growth and job creation," he said. Taxes should not be increased to cover shortfalls, he said.