ECB Constancio: Fully Healthy Bank Sector Won’t Guarantee Quick Economic Rebound

By Todd Buell and Christopher Lawton

The Wall Street Journal, April 10, 2014. All Rights Reserved.

The euro zone faces problems that are more profound than just weakness in the banking sector and that are harder to address, European Central Bank Vice President Vitor Constancio said Thursday.

In remarks prepared for delivery in Washington, Mr. Constancio said that even if banks in the euro zone could completely erase the damage from the financial crisis, it wouldn’t be a guarantee that strong growth and low unemployment would return quickly.

The ECB has placed great emphasis on its assessment of banks’ balance sheets, which it is carrying out before becoming the single currency’s banking supervisor later this year. It is hoped that the exercise, culminating in a stress test, will force banks to clean up their balance sheets, raise capital, which should put them in a stronger position to lend to the real economy.

But Mr. Constancio said this story line is too simplistic.

Firstly, "bank balance sheets in the euro area have to a large degree already been repaired," he said. Furthermore, he said it was "far from clear that finance is a sufficient condition for jump-starting growth in Europe."

"Even a complete rehabilitation of the euro area’s banking system…will not guarantee a quick return to high growth and low unemployment," he added. The euro zone’s economy faces numerous issues, he said, that are "are potentially more serious than the damage inflicted by the financial crisis and the subsequent euro area crisis on the euro area banking sector. These issues are also far more difficult to address."

Mr. Constancio mentioned three issues that he called the "chief obstacles" to growth in Europe: the "remarkable" slowdown in emerging markets, the "large" drop in domestic private investment in Europe since the financial crisis, and weak domestic demand.

The last point "is often left out of the public discourse, but micro evidence suggests that it is a problem that cannot be underestimated." He added that survey data suggest that euro-zone firms face problems on the demand side that are more serious than problems coming from bank lending.

Mr. Constancio said that while bank deleveraging "certainly plays an important role in the inadequate current levels of credit supply to the real economy, factors related to the demand side are even more important," he said.

Lending to the private sector has been declining in annual terms for nearly two years in the euro zone and many experts have said that this is a signal of the weakness of the recovery in the currency bloc and a factor that may force the ECB to pump more money into the 18-nation currency bloc.

Mr. Constancio, however, said that a "creditless" recovery is "far from unusual," especially after a financial crisis.

He said that based on current trends, the euro zone faces a future over the medium term of "stable but low growth, with unemployment evolving to lower levels in 15 years as a result of a declining active population."

"Europe has to react swiftly if it wants to avoid a whole generation being wasted and sacrificed," he said.

Turning to monetary policy, he said that while ECB policy will continue "to provide stimulus", the central bank can’t be called upon to "do everything." Indeed, "people seem to expect too much from central banks." Rather, governments must accept responsibility to promote investment, increase demand, and implement active labor market policies, he said.

In an apparent reference to Samuel Beckett, Mr. Constancio said that commentators have been "waiting for the Godot of a new wave of technical innovations that will save the day" out of a trap of low growth and low inflation.

"Maybe it will come," he said. "But I am sure that we also need active policies and new economic thinking to deal with the income distribution problems that the coming technology will aggravate as well as the role of finance and demand in monetary economies where it is wrong to try to reduce macroeconomics to narrow real and long-term supply-side considerations, as our present predicament so impressively demonstrates."