The central message from the G20 Summit in Brisbane last weekend was the need for more growth, and there was a clear sense after the meeting that leaders are worried. David Cameron captured the mood with his statement that “red warning lights are flashing on the dashboard of the global economy” and his concern about “a dangerous backdrop of instability and uncertainty.” While Europe came in for the most criticism (Christine Lagarde rightly worries that high debt, low growth and unemployment may yet become “the new normal in Europe”) concerns about growth in Japan and emerging markets also weighed on leaders. In the end, though, the diplomacy conducted on the sidelines was more meaningful than the growth proposals put forward at the summit.
Over the past year, Europe has enjoyed calm financial markets. At the core of the market’s comfort were two assumptions about policy. First, that the European governments would do just enough to keep the process of European integration moving forward. Second, that the ECB would, in the words of Mario Draghi, do “whatever it takes” to save the euro. The centerpiece of the ECB’s subsequent efforts was expanded liquidity (through long-term repurchase operations and easier collateral requirements for banks to access ECB liquidity) and a commitment to purchase government bonds to support countries return to market (the OMT program). Even many pessimists who fear that Europe is trapped on a unsustainable, low-growth trajectory remain optimistic that Europe will do what it takes to navigate the near term risks. It may be time to question that optimism.