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Eurozone stagnation hinders Scottish economic recovery

LAST week I visited Germany - Dusseldorf to be precise - for the first time for a year or more.

MARIO DRAGHI: The governor of the European Central Bank has suggested fiscal easing through tax cuts or increased expenditure on infrastructure.
MARIO DRAGHI: The governor of the European Central Bank has suggested fiscal easing through tax cuts or increased expenditure on infrastructure.

This was memorable for at least two reasons.

First I found an audience, perhaps the last on the planet, which had not heard the joke about pandas and Tory MPs in Scotland. They roared at my humour and originality.

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More substantively I had some very interesting conversations with business folk there, German and British, about the state of their economy, what is happening in France and elsewhere in the eurozone and the appropriate policy for the European Central Bank (ECB).

These conversations confirmed me in the view that it is not only in the UK that we have no real idea as to where to go next in terms of monetary and fiscal policies to underpin and sustain recovery in the wake of the dramatic recession which still dominates business and policy considerations.

To cover the UK end first, this newspaper has already cited my disappointment at the news that two members of the Monetary Policy Committee voted for an interest rate hike at the committee's last meeting.

I see no justification for their vote, and sincerely hope that Governor Carney and the remainder of the committee will stand firm against a rate rise for a goodly number of months yet.

There is no hint of inflation pressures, domestically or internationally.

Further, an early upward move on UK rates - ahead of our peer group - would place unwanted upward pressure on sterling, as well as inhibiting business investment and consumer spending.

The recent report from Scottish Engineering showed that a combination of sterling strength and a return to real weakness in our key markets at the core of the eurozone has stalled recovery of this critical sector - and the same must apply to other Scottish and UK exporting sectors.

Certainly that is the implication of the latest summary of business conditions from the Bank of England Agents.

For a balanced and sustainable recovery we need export growth and a real recovery in business investment.

Keeping interest rates where they are until at least the second quarter next year is a necessary part of the equation for achieving these ends.

The US Federal Reserve is also still holding off on moves to tighten monetary policy, but policy-makers there face a similar dilemma to their counterparts at the Bank of England.

In brief, the question both groups are asking is why are wage rates so incredibly sluggish while unemployment continues to surprise on the downside?

Is there a risk that capacity constraints will begin to emerge soon, leading to inflation pressures via the labour market?

Should they be anticipating such problems and tighten soon, or can they afford to wait and see a while longer without placing medium-term stability at risk?

The view of seven MPC members is, yes, they can wait; and fortunately this view looks set to prevail here and in the US well into 2015.

The eurozone faces very different problems.

Recovery there from the 2008 woes has simply never become established.

The problems these days lie not so much at the periphery, as at the core.

Germany is stagnant, as is France, while Italy has returned to recession.

No wonder many Scottish companies are finding it tough to export.

The key policy question in the eurozone is not when tightening should commence, but whether further policy easing is desirable.

Should the ECB engage in its own form of Quantitative Easing (QE) and pump some substantial funds into the ailing economy?

Should governments also contribute by easing fiscal policy - more government expenditure and at least a halt to any thought of tax increases?

These issues were all discussed at the annual central bankers' package holiday/staff outing to Jackson Hole in Wyoming, with no firm consensus emerging.

Mario Draghi, governor of the ECB, pointed to a decline in his patch in inflation expectations, implying possible QE from the ECB alongside a boost from government fiscal policy. But there were only hints, no suggestion of early action.

One cause of delay must be continuing disagreement between Germany and France.

The Germans continue to believe in prudence, while the French government is being reincarnated in confusion after the sacking of the economy minister.

The fact that Frau Merkel and M. Hollande appear not to be the best of chums adds a further complication.

The likely line from Berlin will be pressure for (limited) further action in both France and Italy to reduce structural deficits.

But Germany is likely to resist both any early move on QE by the ECB and any thought of help from the German Federal Government in following up Draghi's suggestion of fiscal easing via tax cuts at home or increased expenditure on infrastructure and the like.

In sum, the core of Europe looks set to remain subdued for some quarters yet, and the risks are very much skewed to the downside.

There appear to be two clear implications from these international conundrums.

First, the MPC should hold its hand as long as possible to avoid further sterling strengthening; and second, Scottish exporters have yet another good reason for looking further afield for markets.

The prospects are positive in a whole host of emerging markets - and the US.

Nobody should count on early signs of growth in the core of Europe.

Jeremy Peat is visiting professor at the University of Strathclyde International Public Policy Institute

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