The European Bank's Underwhelming Surprise
Only three of the 70 economists polled by Bloomberg News had been expecting the European Central Bank to cut its main refinancing rate and marginal lending rate by 25 basis points. I'm not sure why this was such a surprise: European economies remain weak and inflation is not a threat.
So how'd it go? While the markets initially reacted with glee at the news, the Italian and Spanish stock indices are actually down for the day while the German index is flat. That makes sense when you consider just how limp the ECB's move really was.
The biggest problem in Europe is that businesses can't get credit. Lending to nonfinancial firms has fallen by 2.7 percent in the 12 months through September, with even worse contractions in Spain and Italy -- despite the fact that sovereign borrowing costs have plunged since last summer. There are many possible explanations for this, the most obvious being the weakness of Europe's banks and continued uncertainty about whether troubled countries will leave the euro area.
Whatever the reason, the ECB's policy changes haven't been flowing through to the real economy. Frustratingly, it seems as if Mario Draghi, the ECB's president, believes that more can be done, yet refuses to do any of those things. We know this because Draghi said that "we continue to monitor closely money market conditions and their potential impact on our monetary policy stance" and that "we are ready to consider all available instruments" at the press conference following today's meeting. The time for considering all available instruments is now.
One option would be outright purchases of government debt, particularly focusing on those sovereigns that face higher borrowing costs than Germany and the Netherlands. While this would be strenuously opposed by German politicians as well as the technocrats at the Bundesbank, the ECB has done it before and should consider doing so again.
Another, more radical, approach would be a facility that subsidized the borrowing costs of the small and medium enterprises that depend on bank loans for financing. Perhaps it could copy elements of the Bank of England's Funding for Lending Scheme, which gives banks unusually cheap financing on the condition that they make more loans to the real economy.
The biggest obstacle to either of these measures is that they would probably cause inflation in the euro area to accelerate. That ought to be a feature rather than a bug, since prices are already increasing far slower than the ECB's official target rate of "below, but close to" 2 percent. According to Draghi, the ECB's forecast is that inflation will remain too slow for a "prolonged period" before gradually accelerating to its target pace. Yet even now the German popular press is warning that interest rates are too low, despite the fact that inflation in Europe's largest economy is also below target. Don't expect much until those attitudes change.
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