European leaders were as ubiquitous as ever at the World Economic Forum, but they didnt hold center stage for a change. The risk of a breakup of the euro has receded in recent months, yield spreads have tumbled, and corporate executives, bankers and investors were only too happy to get back to business as usual at the Davos, Switzerland networking extravaganza.
For Mario Draghi, the man whose promise to do whatever it takes to save the euro is largely responsible for the new optimism, the recent tranquility in markets was cause for celebration. The European Central Bank president called 2012 the year of the relaunching of the euro, and claimed that the creation of a new European bailout mechanism and efforts by many governments to rein in deficits and enact structural reforms had unleashed a positive contagion in financial markets.
It was telling that Draghi, arguably the most powerful man in Europe, addressed a half-empty Congress Hall on Friday despite having the forums main stage for a prime-time slot. Attendees apparently felt confident enough that the euro crisis was contained to take in such other Davos seminars as, From Tribalism to Globalism: The Evolution of Human Cooperation.
Its a fragile confidence, though. Europe may have averted disaster, but there is still little sign of growth, without which the bloc cant resolve the debt crisis. The International Monetary Fund downgraded its forecast for the euro area at the outset of the forum, predicting the economy would contract by 0.2 percent this year instead of expanding by 0.2 percent, its previous call.
Despite the poor outlook, there was little talk of trying to jumpstart the economy. Austerity remains the order of the day in peripheral euro zone countries as well as in Italy and France, whose debts and deficits dont permit any relaxation of policy. In Germany, the only big country with room to do some fiscal stimulus, the very word remains verboten. Chancellor Angela Merkel reiterated her deficit-cutting orthodoxy in an address to the forum, saying that fiscal consolidation and growth are basically two sides of the same coin.
Whats left is a hope that deficits will continue to come down, labor market reforms will take hold, and confidence and growth will gradually return. That will take time. What if something goes wrong in the meantime? Jeromin Zettelmeyer, deputy chief economist at the European Bank for Reconstruction and Development, says he worries about Italy. If the countrys recession persists and bad debts start to mount at Italian banks, will the EU have the capacity to respond the way it did to bail out Spanish banks last year? he asks.
Barry Eichengreen, economics professor at the University of California at Berkeley, noted that euro area governments had slowed work on some of the key institutional reforms designed to support the single currency. A common bank supervisory regime headed by the ECB is due to be finalized in coming months, but work on a resolution mechanism for failed banks and a common euro area deposit insurance system key elements of the blocs proposed banking union has been shelved for now because of German opposition. Given the limited progress, Eichengreen contended that markets have swung from undue pessimism about the euro last year to undue optimism currently.
Mark Carney, the Bank of Canada governor who will move to London this spring to take over as head of the Bank of England, cautioned that the ECBs pledge to buy bonds if needed had been crucial but not decisive in defusing the debt crisis. Central banks can reduce tail risks, such as a breakup of the euro, but cant eliminate them, he told the forum. Only governments can do that, he argued, and it will take years at best to complete the agenda of fiscal sustainability, structural reform and banking union, he added.
As Kenneth Rogoff, the Harvard University economist and co-author of the definitive book on debt crises, This Time Is Different, put it, I think what the European Central Bank has done is bought two years, five years, seven years, but not 20 years.