Christine Lagarde has just taken on the role of president of the European Central Bank, arguably the toughest job in the European Union governance structure. This job includes the responsibility to set eurozone rates, controlling the supply of euros and overseeing the biggest and most significant banks in the eurozone.
Lagarde’s predecessor Mario Draghi has a mixed record of achievements in his eight-year stint at the ECB. He had undoubtedly saved the euro from a complete collapse when the financial crisis erupted in Ireland, Spain, Portugal and Greece just over a decade ago. He will always be remembered for his proverbial commitment ‘to do whatever it takes’ to save the euro and possibly the EU itself.
However, the EU’s fragmented governance system has led to dangerous political inertia that has prevented member states from implementing the economic reforms needed to stimulate growth in the EU and reduce unemployment. Many analysts are rightly arguing that the biggest threat to the EU is the Japanification of the European economies – low growth, low inflation and low-interest rates. This is certainly not what Europe’s ageing population needs.
Lagarde faces a divided governing body in the ECB. The more economically successful countries, Germany, Holland and Austria, have openly disagreed with Draghi’s commitment to print more money to buy bonds of weak member states like Italy and to reduce interest rates to record low levels. Who can blame those analysts who claim that the ECB’s flow of cheap money is creating bubbles in property markets and supporting zombie companies that would otherwise collapse?
There is a limit to how far and how deep you go into negative territory
While the ECB as the eurozone’s banking supervisory is insisting that banks derisk their business models, at the same time it is endangering their profitability by inflicting negative interest rates. Lagarde has so far not distanced herself from this controversial strategy and argued that low interest rates and printing money to buy risky sovereign debt had had more advantages than disadvantages.
She will certainly have to convince the German, Dutch and Austrian representatives on the governing board of the ECB of the soundness of her predecessor’s favourite strategy to combat the sluggish economic growth in the EU.
Lagarde’s political and diplomatic skills are evident when she said: “There is a limit to how far and how deep you go into negative territory. There is a bottom to everything, but we are not at that bottom at this point in time.”
This partial acknowledgement of the weakness of the low interest rate strategy should help her bridge the gap with the more hawkish European central bankers sitting on the governing board of the ECB.
Oliver Blanchard, a former chief economist at the IMF for four of Lagarde’s eight years as managing director, makes a very sobering comment. “Monetary policy is almost out of ammunition, but if the central banks say this too explicitly, the markets will freak out. Lagarde has to do this delicate balancing act of saying there is more she can do, while insistently asking others, including fiscal policymakers, to help.”
Lagarde, who is not an economist, is using all her communication and political skills to speak loud and clear on what needs to be done to reverse the trend of long-term economic decline. She has urged the German government to start using its fiscal surpluses to invest more in the green economy, education and the infrastructure. The beggar thy neighbour practices adopted by the more frugal member states are only helping to perpetuate the poor economic performance of the Union.
The geopolitical risks that have been looming of the past few years are still a serious threat to the EU. The IMF has cut its growth forecasts to the lowest level since the 2008 crisis, blaming US-china trade war and uncertainty over Brexit. Germany’s export depend economy has been hit particularly hard and the country facing a recession.
In many ways, Lagarde is very different from Draghi. She is not an economic expert and less of a technocrat than her predecessor. However, she has an outgoing, warmer personality and is a better communicator. Markets have welcomed her appointment.
The main thrust of her strategy may be the insistence on more investment in the green economy to deal with the negative effects of climate change. However, she may face more resistance from the German Central Bank that still embraces conservative monetary policies.
Average EU citizens are likely to prefer the straight-talking of Lagarde especially when she reminds lethargic politicians about their responsibility to reform their economies.