The ECB Should Cut Rates, Then Go Furtherby
Economists surveyed by Bloomberg News expect the European Central Bank to cut interest rates after the ECB’s policy-making board meets Thursday. We hope this forecast is right -- and that the ECB doesn’t stop there.
Most of those in the survey predicted that the bank’s benchmark rate would fall 0.25 percentage point to 0.75 percent, a new low. The forecast sounds right. Europe’s economy isn’t improving. The average unemployment rate in the euro area rose to a new high of 11.1 percent in May, according to figures released this week. With public debt already too high, the scope for fiscal stimulus in the worst-hit economies is zero. That leaves monetary policy.
Last week’s of European Union leaders finally made progress in coordinating a joint response to the financial crisis. Markets greeted the new moves with enthusiasm. The cost of Spanish and Italian government borrowing fell from unsustainable highs, and the euro gained ground. The ECB will want to keep up the momentum by following political advances with new monetary action, as it has in the past.
In truth, though, a further cut in interest rates is only the beginning of what the EU needs. At last week’s summit, euro-area governments agreed in principle to extend support to distressed banks directly, rather than through their governments. Markets had judged an earlier bank-support plan for Spain no good because it would add to Spain’s public debt and push private claims down the payment line in the event of default. The promise to help banks directly, together with an assurance that the planned support for Spain wouldn’t skip ahead of earlier claims, was what markets wanted to hear.
The new bank-rescue plan, however, depends on progress in moving toward a European “banking union” with a single supervisor and maybe joint arrangements for deposit insurance and bank resolution. Governments have pledged to work on this, but the details aren’t clear. The best approach would be to lodge the new powers in the ECB, and then draw the boundary of the union so it corresponds with membership of the euro area.
This would greatly enlarge the ECB’s role -- and that’s the idea. Too much diffusion of authority has delayed the EU’s response to the crisis. As quickly as possible, the EU ought to simplify its financial governance and consolidate its powers to intervene in an emergency. The ECB is the right vehicle.
There has been less progress on another issue involving the ECB: quantitative easing, in which the central bank prints money to buy government debt. The ECB continues to hold back from this measure, arguing that its rules forbid direct lending to governments.
The rules or their interpretation should be changed to give the ECB the same tools as the Federal Reserve and the Bank of England, both of which have signaled a willingness to buy more bonds if the recovery slackens. At the EU summit, leaders agreed to let the European Stability Mechanism, the new permanent rescue fund, intervene more flexibly in debt markets so that borrowing costs in Spain and Italy could be capped. A good idea -- except that the 500 billion euros ($630 billion) available to the ESM is far too small to be a credible bulwark. The ECB needs to stand behind the rescue fund with the bank’s effectively unlimited spending power, or else buy debt itself.
Thursday’s ECB meeting will probably end with a cut in interest rates, which is surely warranted on its own terms. Containing this crisis, though, will require bolder steps -- steps that Mario Draghi, the central bank’s chief, will need political backing to take. The sooner Europe’s leaders agree to them, the better.
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