Improving EMU's incomplete architecture

THE Economic and Monetary Union (EMU), long dogged by failure to complete its initial architecture and design, faces both shorter and longer-term problems. Among measures to help resolve issues in the first category, the European Central Bank (ECB) on Dec 3, 2015, extended its asset-purchase programme by six months until end-March 2017, taking total asset purchases to 1.5 trillion euros (S$2.35 trillion) and broadening asset eligibility to include local and regional debt.

Inflation has been persistently below the ECB's 2 per cent objective since January 2013, below one per cent for almost two years, and below 0.5 per cent for 16 consecutive months. Inflation isn't the European Union's (EU) only concern; there are many more, including Europe's anaemic growth record, its 22 million unemployed and the escalating refugee crisis.

The euro area's macroeconomic framework contains the following elements: internal devaluation in some distressed peripheral countries (cuts in real wages with little productivity gains); fiscal devaluation in other countries (shifts in taxes away from labour towards indirect taxes); and fiscal consolidation accompanied by private debt deleveraging. Unsurprisingly, the result is poor growth and low nominal demand. The ECB's quantitative easing (QE) makes sense: Inflation is always a monetary phenomenon, so combating low inflation requires monetary policy. However, euro-area nominal demand has been persistently weak.