The current decline experienced by Eurozone economy is quite a mystery. Some say that it started from the debt crisis a while back that is still a nightmare to this day, and some say that Euro area has just entered the lower stage of economic cycle. But is that all there is to it?

The current decline experienced by Eurozone economy is quite a mystery. Some say that it started from the debt crisis a while back that is still a nightmare to this day, and some say that Euro area has just entered the lower stage of economic cycle. But is that all there is to it? The main thing we have to remember is that the Eurozone comprises of several different entities with political and economic structure that is unlike any other country. This fact makes recovery becomes more complicated.

Weak Macro Indicators

Almost all macro indicators in Euro area is in decline or stagnated. The ultimate problem is, of course, slowing GDP growth. But rife unemployments, falling inflation, and high debts, are three indicators that have to be improved in order for the Eurozone to recover.

1. Latest data of overall Euro area unemployment stands at 11.50%, with highest number of unemployed resides in Spain and Greece. Job market actually has  improved slightly from the 12% it was in 2013. However, as with many unemployment data, the actual figure could be higher.

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2. Latest inflation rate is recorded at 0.4% yoy, the eleventh consecutive below-zero inflation in the Eurozone. Unlike the-slightly-improved unemployment, prices are significantly worrying. At this juncture, what the decision makers do would determine whether the Eurozone will wither away in recession like Japan a few years ago, or enter recovery stage it needs to be.

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3. Latest record of Euro area overall debt-to-GDP ratio is at 92.6%. Taken separately, there are even countries with over 100% ratio. In comparison, Japan debt-to-GDP ratio exceeds 200% and the US exceeds 100%, but oil producer countries like Saudi Arabia and Iran are usually significantly lower. Eurozone's debt-to-gdp ratio was so close to 100% that German Chancellor Angela Merkel insisted all countries in the Eurozone to adopt austerity measures. Austerity is a policy directive that aims to reduce national deficit by cutting public spending and increase taxes.

However, there are questions as to how effective austerity is to improve economic conditions. Theoretically, reduced government spending shall cut down risk of debt default and its contagion. But on the other hand, austerity discourages businesses from expansion and hiring due to the high taxes and few incentives. We can see business sector low confidence from the dismal PMI index performance. Flash Eurozone Manufacturing PMI for September 2014 dropped from 50.7 to 50.5, its lowest in 14 months.

Demand For Quantitative Easing

While committing to loosen monetary policy, the European Central Bank President, Mario Draghi, have repeatedly warn Eurozone leaders of the need for structural reform in the area. He recognizes the ECB responsibility to do what it can to stem falling inflation, as well as its inability to cope without the cooperation of all stakeholders. Yesterday (22/9) Draghi spoke at a meeting of the European Parliament's Economic and Monetary Affairs Committee in Brussels, We stand ready to use additional unconventional instruments within our mandate, and alter the size and/or the composition of our unconventional interventions should it become necessary to further address risks of a too prolonged period of low inflation.

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Last week, demands for ECB's TLTRO loan program was lower than expected, and so it will be offered again in December. ECB have planned an ABS-buying program to be announced next month, but TLTRO low demand and Draghi latest statement also spurred expectations for the ECB to adopt broader measure such as Quantitative Easing (QE). And really, if we think about it, when all else fails, what could the European Central Bank do but take the QE way?

It needs to be noted that the infamous practice of strict austerity among European countries is the direct opposite of stimulus. To put it simply, if austerity continues, then it is like the ECB pours money into the economy while the governments are keeping their purse tight and absorbing every cent of money in the economy. Well, ten minus ten equals zero, and as such, the Eurozone economy will go nowhere. The dilemma is, if austerity is being scrapped, then government debts possibly will soar and put the Eurozone at risk of repeated debt crisis. The solution might be a limited relaxation to budget spending which is not high enough to incur debt crisis, funded by the ECB QE. Still, although it is possible, it is not likely will get rid of the source of problem.

In previous occasions, Draghi have appealed Eurozone country's leaders to enact new policies in order to reform the government, as well as fiscal stimulus. He once again plead his case in the European Parliament, As I have indicated now at several occasions, no monetary and also no fiscal stimulus can ever have a meaningful effect without such structural reforms. Reuters underlined his argument that the crisis would only be over once confidence returned and companies were willing to take risks again, invest and create jobs, which depends most on the implementation of structural reforms and improvements in the competitiveness.

The Need For Structural Reform

The Eurozone is what Southeast Asia aspire to be. Beginning from a conference of sort, then bonded through cooperation in various sectors, transformed into an exclusive union to ensure the region economic stability and progress, and afterward managed to build a currency union. Such unification is being seen as the future where every country within it could better advance themselves and reach a pinnacle that has not been reached before. Together as a single economy, the Eurozone is the largest economy in the world, surpassed even the US and China (based on IMF and World Bank data, 2013); an exceptional feat that could not possibly be reached by any of the European countries singularly but easily attained after the union. But as the Eurozone has experienced, that noble objective is not so easy to be achieved.

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Firstly, the gap between countries stands in considerable size. Germany as the largest economy has GDP of 3,636 billion USD (20.9% of EU GDP), followed by France at 2,737.4 billion USD (15.8%). If the UK join in the single currency, then UK will be the third biggest, but meanwhile, Italy stands in the third seat with just 2,072 billion USD, or 11.9% of EU GDP. On the other hand, the other countries are not so wealthy. Greece has only 241.8 billion USD of GDP (1.4%), Slovakia at 95.8 billion USD of GDP (0.5%), and so on. Such gap put the burden on Germany to shoulder the responsibility of being machine of growth.

Second, the design of the Eurozone is flawed. Hamish McRae from the Independent mentioned that a countroversial book titled The Euro Trap by Hans-Werner Sinn of German Ifo Institute argued how the design of the Eurozone is fundamentally flawed. McRae underlined, It encouraged huge capital flows into southern European countries, which undermined their competitiveness and made them vulnerable to the US-provoked global crash. Bailouts and austerity followed. But now the combination of the huge burden of debts and the rigidities of the eurozone prevent countries from escaping. To put it simply, the current decline suffered by the Eurozone is a path that it has to pass through by structural reform.

Third, the Eurozone comprised of many countries with their own complexities. Therefore, the establishment of the Eurozone by itself limits how much the central bank will be able to intervene in domestic affairs. Central bank as monetary authority have long been established in many countries as separate entity from the government as the holder of fiscal authority, but there is typically a certain degree of similar political interest and economical objective. Such characteristic is missing in the ECB's relation with the Eurozone respective countries. Add that with conflicting interest among countries and politicians, and it explains why Draghi pleas are falling in deaf ears.

As Nobel-winner economist Joseph Stiglitz wrote in January, With European leaders wedded to austerity and moving at a glacial pace to address the structural problems stemming from the eurozone's flawed institutional design, it is no wonder that the continent's prospects appear so bleak. If we could put it in a word, what the Eurozone economy needs now is structural reform, not mere financial stimulus. Unlike the US economy that started to recover along with the enormous amount of stimulus channeled by the Fed, the same strategy might not work as well in the Eurozone. As long as there is no structural reform, then the Eurozone is in for a long-lasting battle against economic setback.


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