The eurozone recovery can be traced back to the ECB becoming a lender of last resort and to a relaxation of austerity policies
Finally, the recession in the eurozone is over: for the first time for almost two years, the region's GDP has grown again in the second quarter of this year. What is more, leading indicators point to a continuing recovery through the summer and autumn, albeit at a rather muted speed.
While German politicians in particular are now claiming that the recovery is a result of "consistent stability-oriented policy", closer scrutiny shows that this claim is not very plausible. Instead, the turnaround can be directly traced back to a reversal in two important areas of macroeconomic policymaking. First, Mario Draghi's decision from the summer of 2012 to make the European Central Bank to a de facto lender-of-last resort for embattled government. Second, the gradual relaxation of austerity policies in the euro area.
Since the onset of the euro crisis in 2010, policymakers have tried in vain to end it. Neither the establishment of the temporary European Financial Stability Facility nor the permanent European Stability Mechanism, both endowed with several hundred billion euros in lending capacities, managed to calm the markets.
The passage of both harsh austerity packages and the fiscal compact – which forces eurozone countries to limit structural budget deficits to 0.5% of GDP – have left financial markets completely unimpressed. Instead, after each new policy measure brought forward by the finance ministers, interest rates on bonds of southern European countries such as Spain and Italy continued to climb and the region's economies slid deeper into recession.
Mario Draghi has been much maligned in the European press, and in Germany in particular, where he has been branded "Draghiavelli". But only when he publicly stated last summer that the ECB would do "whatever it takes" to save the euro, announcing that the central bank would be willing to buy government bonds under the newly created Outright Monetary Transactions programme, did spreads between yields on periphery bonds and German bonds start to fall.
This fall in government spreads did not only benefit the treasuries of the embattled crisis countries. Since interest rates corporations have to pay follow closely that of their government, the reduction in spreads has also led to a relaxation of credit conditions for the private sector in the periphery countries. With the standard lag of interest rates influencing the real economy, the improvement in credit conditions can now be seen in economic activity.
Second, the breakneck austerity course Europe had embarked on in 2010 is slowly coming to an end. While this policy change did not attract as much public attention as Draghi's words and actions, it is no less real. As even the IMF has now acknowledged that austerity did not work quite as well as it originally believed, crisis and non-crisis countries across the continent have been given more time to get their fiscal balances in order.
According to the most recent forecast of the European commission, the structural budget deficit in the euro area has been reduced by 3.7% of GDP between 2010 and 2013. Yet, from 2013, no further tightening of fiscal policy is predicted. Instead, the structural budget deficits are expected to remain at roughly 1.5% of GDP over the coming year. Italy, Spain, France; in each of these countries, austerity measures are now pushed into the future not to derail the business cycle further.
And, what is more important, contrary to its attitude over the past years, the austerity preaching German finance ministry has quietly accepted these adjustments. The combination of lower interest rates and a slower path of fiscal tightening has done exactly what standard textbook models would predict: it has given the economy more breathing space and the private sector activity is now recovering.
Is, then, all well now? Unfortunately not. So far, this is not a self-sustaining recovery with strongly growing private investment, disposable income, falling unemployment and growing consumption. The crisis can still re-emerge like a monster from a B-movie. A new failure of governments in countries such as Italy and Spain might again spook the markets.
An adverse ruling by the German constitutional court on OMT (a case is to be decided this autumn) could also create new uncertainty and send spreads up again. Draghi might then still come to a rescue by actually implementing OMT and start buying bonds but, in the process, the recovery can easily be derailed.
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