Europe Needs the Policy That Dare Not Speak Its Name
The European Central Bank's decision to leave interest rates unchanged is a mistake. Europe's economy is in danger of slipping into deflation, and the risks of doing nothing outweigh the risks of doing too much.
Investors took the central bank's inaction, announced Thursday, calmly. Many expect a move toward fresh monetary stimulus next month, when the ECB will have a new quarterly forecast and other data in hand. In his news conference after the meeting, ECB President Mario Draghi stressed the need for more information and said the central bank would act if deflation loomed. But he also played down the danger and said the European economy was showing signs of life.
This is too optimistic. Inflation in the euro area fell yet again in January, to 0.7 percent -- lower than expected and less than half the ECB's target rate. The region's gross domestic product was essentially flat in the third quarter of 2013. Next month, Draghi will have fourth-quarter numbers to consider, and there are recent signs of an uptick in European manufacturing. Still, the recovery remains weak at best.
If deflation begins, real interest rates will rise and the region's debt burdens will press down even harder. Any nascent recovery will stop. It's vital to avoid a ruinous downward spiral. Immediate action would have been best; failing to ease next month will be impossible to justify unless convincing signs of faster growth and higher inflation are quickly apparent.
Maybe so, you might say, but what can the ECB do? Plenty. Despite the region's dismal performance, it hasn't yet cut interest rates to zero. At 0.25 percent, its benchmark rate can be trimmed again. And it could encourage banks to lend by charging them interest (rather than paying them interest) on their deposits at the central bank.
Either of those options, and preferably both, would tell investors that the ECB is willing to act, which would provide valuable reassurance. Neither measure, though, would do much to directly stimulate demand. For that, an asset-purchase program of the kind used by the U.S. Federal Reserve would be needed.
Admittedly, when it comes to quantitative easing, the ECB is more tightly restricted than the Fed. It's prohibited from lending directly to governments, and Europe's monetary conservatives, led by Germany's Bundesbank, have long argued that the spirit of that injunction also rules out lending to them indirectly. That's debatable. There's wiggle room -- and the ECB should exploit it more boldly.
The ECB's Securities Markets Program, adopted at the height at the financial crisis, was a timid step in the right direction: In certain circumstances, it allows the ECB to buy assets it had previously accepted as collateral. A newer asset-purchase program called Outright Monetary Transactions still hasn't been used and is under review at Germany's constitutional court. Both programs were narrowly conceived. They were designed to relieve financial systems in distress rather than provide monetary stimulus across the euro area.
A month from now, unless there's good news in the meantime, Draghi and the ECB will need to confront that inhibition. With the risk of deflation looming, the euro area needs to talk about the policy that cannot be named and prepare itself for Fed-style quantitative easing.