The eurozone economy is stuck in a long and drawn-out recession. It will probably continue for the rest of the year. Unemployment has reached a eurozone-era record of 12 per cent, and will probably rise further. Inflation is at the lower end of the target range, and projected to fall. The risks to growth and inflation are both on the downside. So why on earth is the European Central Bank not cutting interest rates?
This is a legitimate question, and an important one. But the most important question facing European monetary policy is how to fix the credit crunch in the southern half of the monetary union.
Nowhere is the situation more acute than in Italy, where small and medium-sized companies are being hit by austerity and the credit crunch at the same time. Mario Monti’s administration in Italy implemented austerity in such a way that it has prevented municipalities and other public entities paying bills to their suppliers. This has turned into an existential threat to the survival for many small companies, which face the simultaneous problem of not getting paid and not having access to credit to tide them over. Small Italian companies typically face interest rates of 10 per cent. Over the border in Austria, similar companies get credit for less than half that rate. Italian households, too, are credit constrained, as lending for mortgages and consumption goods has been steadily falling, and rates rising.