The warning signs are flashing red for the eurozone.
Inflation is plunging, unemployment is rising and activity is weakening across the board. Unless Europe wants to become the next Japan, mired in permanent deflation and depression, action is needed now.
Stage one of the process should be a cut in interest rates from the European Central Bank (ECB) when it meets in Bratislava on Thursday. The latest inflation figures show the annual increase in the cost of living across the 17-nation single-currency area fell from 1.7% to 1.2%, its lowest in three years and well below the ECB's 2% ceiling. Even Jens Weidmann, the ultra-hawkish president of Germany's Bundesbank, would be hard pressed to say there is a threat to price stability.
It's not hard to see why inflationary pressure is abating: the eurozone economy has been flat on its back for the past 18 months. Unemployment rose by 62,000 in March, taking the eurozone jobless rate to yet another record high of 12.1%. Spain and Greece remain the weak spots, but even in Germany labour market conditions are becoming more difficult. Across the eurozone, almost one in four young people are out of work.
Why is unemployment rising? Again, you don't have to be John Maynard Keynes to figure it out. Europe's banking system is bust, there is a shortage of credit, real incomes are under pressure and the deficiency of demand is being exacerbated by austerity overkill. Retail sales figures from Greece show that in February spending was more than 14% lower than a year earlier.
The malaise is spreading from the eurozone's periphery to its core. It will be mid-May before the official growth data for the first quarter of 2013 is published, but the early evidence from Spain, where GDP fell by 0.5%, is not encouraging. Judging by the grim forward-looking surveys of business and consumer confidence, the second quarter will suffer more of the same.
Monetary policy works only with a lag, so whatever the ECB does on Thursday will be too late to prevent the recession deepening. Angela Merkel has made it clear that she does not want to see a cut in the cost of borrowing, but it is time for the ECB to show its independence and act in the interests of all eurozone citizens, not just the one seeking re-election in the German polls this autumn.
In itself, a quarter-point cut in interest rates to 0.5% would do little to revive demand, ease the credit crunch or create jobs. Instead, it should be part of a three-pronged approach to boost growth. The cut in rates should be accompanied by an ECB announcement that it is willing to embrace the unconventional methods deployed by the Federal Reserve, the Bank of England and Japan to underpin activity. It should also be the catalyst for a less aggressive approach to cutting budget deficits, with countries given more time to bring their deficits below the eurozone ceiling of 3% of GDP.
For the past three years, macroeconomic policy in the eurozone has been run on sadomasochistic principles: that only regular doses of pain will ensure countries stick to strict reform programmes.
The upshot of this policy is clear for all to see. Businesses that are starved of credit are mothballing investment and cutting their workforce. Weaker growth means higher-than-expected budget deficits. Permanent austerity has bred social dislocation and political extremism. A different approach is needed to save the eurozone from catastrophe – starting on Thursday.
guardian.co.uk © Guardian News and Media Limited 2010