On Thursday, the European Central Bank is scheduled to meet and decide whether to act on ECB President Mario Draghi’s pledge last week that it will “do whatever it takes to preserve the euro.”
That dramatic statement raised hopes among many world leaders and global investors that the ECB would escalate its efforts, in combination with strong European governments like Germany, to buy up huge amounts of Spanish and Italian government bonds. The aim would be to ease the debt crisis facing those countries and the financial troubles buffeting the continent. Stock markets surged last week on the newfound optimism.
But the actions by the Fed and ECB aren’t likely to dramatically change the prospects for the U.S. and European economies. Markets fell modestly this week after hopes about central bank action faded into a more sober realization about the limits of what they can do.
In the United States, the Fed has been waging a campaign for four years to stimulate economic growth, but the efforts have been growing less effective.
The main domestic threat to the economy is a series of deep federal cuts in spending and sharp tax hikes set to take effect at the end of the year, which are expected to plunge the economy into recession.
Only Congress and the president can avert that outcome.
In Europe, the ECB has reluctantly become the first responder to the continent’s financial crisis.
After Draghi’s comments last week, anything short of a dramatic bond purchase program may disappoint investors who have seen the continent’s political and economic leaders routinely underestimate the depth of the financial challenge.
Over the long run, however, the ECB can only provide temporary support to the European financial system. To achieve economic growth and stability, leaders in Greece, Spain, Italy and elsewhere must make tough political choices about how to manage their government finances.
Greek leaders will need to reassure the country’s creditors that government debts can be reduced without undermining economic activity. Spanish leaders will need to make sure that their country’s banking system can weather its difficulties, while both Spain and Italy must take steps to stimulate economic growth without being profligate.
While the ECB can prevent an “immediate financial implosion, it cannot itself engineer the adjustments required to set the stage for a revival of investment and employment,” said Michael Gavin, an analyst at Barclays Capital, in a research note on Tuesday. “That will take forceful policy action and time.”