The European Central Bank's complacency about deflation is starting to look like recklessness. Inflation in the euro area fell again in March, to
A simple conclusion follows: The ECB is failing to discharge its mandate to keep inflation "below, but close to" 2 percent. At its policy meeting Thursday, it should act.
Some analysts have suggested reasons to disregard this latest unexpected drop -- citing Easter's place on the calendar this year and other supposedly distorting factors -- but they've been saying this for months, and inflation in the euro area keeps drifting down. It's been closer to zero than to 2 percent since November.
Europe's economies are recovering, but far too slowly for the threat of deflation to be dismissed. Unemployment in the euro area still stands at almost 12 percent. If deflation gets a grip, this slow progress will cease altogether.
It's also true, as the ECB likes to point out, that the picture varies from country to country -- but the range of conditions is hardly reassuring. Inflation is running at 0.9 percent in Germany, one of the euro area's healthier economies, while prices are already falling in Spain, one of its sickest. (The risk of deflation is Spain is "not zero," the governor of Spain's central bank noted last week. You don't say.)
The dangers of deflation are well understood, especially for economies burdened with debt, as Spain and many others still are. Falling prices make debts weigh more heavily and threaten to sink distressed economies into an even deeper hole. The ECB understands this. So why hasn't it acted already?
The reason is that Europe's governments have allowed their central bank much less freedom of action than the U.S. Federal Reserve or the Bank of Japan have. With the short-term interest rate at close to zero, the ECB can provide further monetary stimulus only if it adopts unorthodox measures. The Fed and the Bank of Japan have relied on large-scale bond purchases, or quantitative easing. The designers of the ECB left the legality of QE in doubt. It's an issue the bank's president, Mario Draghi, would rather avoid.
It can no longer be avoided -- not, at least, if the ECB takes its mandate on inflation seriously. The legal strictures on the ECB leave it room to maneuver, and this should be exploited. The bank has already announced (but has not yet deployed) a program called Outright Monetary Transactions, which involves bond purchases for the purpose of stabilizing markets in distressed government debt. The OMT program was narrowly conceived, but with some legal ingenuity, it could be recast as QE for stimulus purposes.
There are other possibilities, too, including measures less fraught with legal complications. The ECB could cut a last sliver from its main refinancing rate. It could charge banks to keep funds on deposit with it. Or it could undertake large-scale intervention in the foreign-exchange market with the aim of driving down the euro. That would be a form of QE, because it would increase the euro money supply. The bank would be buying U.S government and other foreign securities rather than the debts of its own governments, so it couldn't be accused of illegally financing its member states.
But the cleanest and most effective form of unconventional stimulus is Fed-style QE. Even Jens Weidmann, president of the Bundesbank and hitherto a harsh critic of QE, recently softened his position, saying it wasn't out of the question. And if Germany can countenance QE as an anti-deflation measure, a way can be found to make it happen. On Thursday, Draghi should say so.
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