Europe and the Zero Bound

As in the U.S., another rate cut isn't enough for faster growth

The European Central Bank turned heads by cutting its benchmark interest rates by 0.25 percentage points on Thursday, though calling it a dovish move would imply that the ECB has been hawkish. The main refinancing rate sat at 0.5% for six months before this week.

The best argument for a rate cut is that euro-zone inflation has been falling all year and came in below 1% in October. The central bank's sole mandate is price stability, which means preventing excessive price changes in both directions. ECB President Mario Draghi made clear Thursday that the lower inflation outlook was the most important calculation behind the rate cut. The central banker has refused to pretend that a 25-basis-point cut in banks' refinancing rate is the difference between euro-zone salvation and damnation, which can't be said of some commentators.

Mr. Draghi also dismissed fears that low inflation is about to turn into a deflationary spiral. Not long ago, moderately improved business surveys were supposed to presage a strong European revival. Now, "dangerously low" inflation is said to threaten the recovery.

As Mr. Draghi pointed out, recent low inflation is due in large part to stable food prices and falling energy prices, as well as the effect of previous VAT increases dropping out of the data. But even a proper, prolonged dose of low inflation wouldn't be the worst thing for Europe.

Inflation has been falling most in euro-zone countries where wages have been falling most, which is good for real household income and consumption in those countries. The one euro country experiencing out-and-out deflation is Greece, where relative price adjustment has been a stated goal of crisis resolution.

A weaker euro will be a boon for German exports, which the U.S. Treasury and others blame for holding back euro-zone recovery. The new government in Germany isn't about to open its spending floodgates, which is what European Keynesians are really demanding when they complain about insufficient German "demand." The better complaint is that Berlin won't cut taxes, which would lift German growth and thus its demand for other countries' exports.

Lower interest rates and more generous central-bank liquidity will also help unfreeze credit in the European periphery. Funding conditions have been looking better of late for euro-zone banks, but those banks still aren't lending to the real economy. Easier money will induce some banks to lower their lending rates. But actual improvement in the growth prospects of countries like Italy and Spain would do more to get credit flowing again.

This goes to the bigger point about Europe's recovery, which is that it is not and has never been in the central bank's hands. Mr. Draghi reiterated on Thursday that fiscal, labor-market and other reforms are the real way out of the euro crisis.

A dose of reform could also help the U.S., which on Thursday reported another quarter of lackluster growth. The topline GDP growth number of 2.8% was better than the details, which included a 0.8% increase in inventories and disappointing business investment.

The danger for many years has been that easy money would remove the pressure on governments to use pro-growth policies to revitalize their economies. As the ECB's rates approach the zero lower bound, the temptation will be to try "unconventional" monetary policy in the form of more asset purchases. Mr. Draghi's challenge is to keep his sights on price stability when all about him are clamoring for more.