Europe Needs More Than Stimulus Lite
European Central Bank President Mario Draghi had primed his audience before today's monetary-policy announcements. In recent comments, he'd led investors to expect new measures to stimulate demand in the euro area's stagnant economy. He had to deliver -- and, to a point, he did. The trouble is, the new efforts still don't go far enough.
First, Draghi cut another sliver from interest rates. The ECB's benchmark refinancing rate goes from 0.15 percent to 0.05 percent, and the rate applied to banks' deposits with the ECB goes from minus 0.1 percent to minus 0.2 percent. These are tiny changes, yet they pleased investors, who'd mostly thought rates could fall no further. Their surprise caused the euro to depreciate -- which is probably what Draghi intended and is all to the good, because a cheaper euro contributes to an easing of monetary conditions in its own right.
What investors mainly wanted to know, though, was whether the ECB was finally ready to undertake outright quantitative easing. Other big central banks, including the U.S. Federal Reserve, have used QE (that is, large-scale purchases of government debt) to expand the money supply, stimulate demand and stop inflation from falling too far. The ECB has talked about it, and flirted with it, and said it was thinking about it, and was maybe preparing to do it -- but hasn't actually done it. Was this about to change?
Kind of. Starting next month, the ECB will buy a combination of asset-backed securities and covered bonds -- repackaged loans of various types. Crucial details, including how much it will buy, are still to be announced, but a couple of points were immediately worth noting.
Europe's pool of suitable asset-backed securities is small; the decision to include covered bonds enlarges the possible scope of the operation. In addition, Draghi explicitly said that the initiatives would have a "sizable impact on our balance sheet." That means they're intended to expand the money supply.
In other words: It's QE-lite. Draghi is no longer insisting that the ECB's asset purchases are intended only to repair a broken "monetary-policy transmission mechanism." The new measures, like Fed-style QE, constitute monetary stimulus that dares to speak its name. But the ECB still hasn't announced a large-scale program of government-bond purchases -- and that's by far the deepest and most liquid market for QE operations. The ECB's reluctance to venture in that direction remains apparent. This puts limits on how effective the new initiatives can be.
Granted, doing more won't be easy. The ECB's governing council wasn't unanimous even in supporting Draghi's QE-lite. (Draghi said he had secured a "comfortable majority." It's reported that Bundesbank President Jens Weidmann opposed both the interest-rate cuts and the plan for new asset purchases.) The practicalities of outright QE are daunting in the euro area: For one thing, whose bonds would the ECB buy? Would it even be legal? It's a form of direct financing of government borrowing, which the ECB is forbidden to do. The ECB's institutional reluctance to embrace the policy is entirely understandable -- but that doesn't make it any less damaging.
Inflation in the euro area now stands at 0.3 percent. The ECB's new forecasts say inflation will be less than 2 percent this year, next year and the year after that. Recent market indicators of inflation expectations have been moving lower. As Draghi said today, the risks in Europe's economic outlook are "on the down side." Deflation is a clear and present danger.
The case for full-scale QE in the euro area has been compelling for months. It's good that the ECB is taking a step in the right direction. It's a shame -- and it keeps Europe's economies at grave risk -- that it's only a step.
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