European Bank's 'Forward Guidance' Is a Murky Path

Evan Soltas is a contributor to Bloomberg View.
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The European Central Bank made history last week, committing for the first time in its 15-year existence to future monetary policy. It's good news that the bank has stopped disdaining the practice, known as "forward guidance," but this is far too small of a baby step.

"Looking ahead, our monetary policy stance will remain accommodative for as long as necessary," the bank said in a statement. "The Governing Council expects the key ECB interest rates to remain at present or lower levels for an extended period of time" in order to support "a recovery in economic activity later in the year and in 2014."

Markets were underwhelmed. They now anticipate interest rates 0.1 percent lower in 2015 than they had before the announcement, according to Euribor futures, which forecast the ECB policy rate.

There was a bit more hope in equity and foreign exchange markets. European stock markets rose two percent, and the euro dropped one percent, within minutes of the announcement.

The limp response may tell some problems with the ECB's approach. First, as Wolfgang Munchau pointed out in the Financial Times, this statement barely meets the definition of forward guidance. It's too vague on how long, and under what conditions, the easing will last. And the whole point of guidance is to commit policy to stay easier than is warranted -- something the ECB isn't allowed to say or do.

Second, it's hard for this hawkish central bank to make a credible commitment to stay easy -- after all, it raised rates in 2011. Much research in economics suggest that only a more dramatic "regime change" can change these impressions.

Third, there's a big difference between what easy money can do for the U.S. than for Europe. The continent's structural problems dwarf those of the U.S. This impedes the work of monetary policy, as no interest rate may be low enough to make Europe into an attractive investment opportunity. (There is, of course, another way -- devalue the euro and inflate -- but this is anathema to Europe.)

Fourth, Europe is late to the party. The lack of an appropriate monetary policy for the last three years has weakened the economy in a way that might not be so easy for a central bank to fix. No amount of monetary "support," say, can give five years back to unemployed young people in depressed periphery economies.

In the U.S., the Fed has been too quick to blame fiscal policy and the government for weak growth. Europe's central bank, however, is too shy. It should press harder for structural economic reform.

One idea is to change the trade of easy money for smaller deficits. The bank should let countries (and encourage them) to substitute some labor-market liberalization, say, for some fiscal austerity. The central bank would be able to boost demand more effectively if European governments inspired some hope, too.

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