Straight Talk Would Give Draghi More Punch
Mario Draghi deserves credit for what he did last week. The European Central Bank's president found a way to surprise investors with lower interest rates and announced a plan that looks a lot like quantitative easing -- both good moves. Nonetheless, the ECB is still falling short. It's supplying too little monetary stimulus, and it's compounding that error by advertising its own impotence.
These failures, by the way, aren't Draghi's fault. They're baked into the ECB's design.
Is it so certain that the euro area needs more monetary stimulus? Yes, if you assume that euro-area fiscal policy can't take up the slack -- and that's where things stand. The ECB's target for inflation is "close to, but below, 2 percent." Actual inflation is now 0.3 percent. That's below 2 percent but it sure isn't close. The ECB's forecasts show inflation running well below 2 percent for the next two years. The prediction for 2016 is 1.4 percent. That still isn't close.
So the only question is whether the ECB's new measures, added to the minor changes it announced in June, go far enough. Taken at face value, the new interest-rate cuts are trivial. The ECB cut its benchmark lending rate from 0.15 percent to 0.05 percent, and it's made the rate on deposits held at the central bank a bit more negative -- cutting it from minus 0.1 percent to minus 0.2 percent. The direct effects will be negligible.
Draghi also announced a new asset-purchase program, to start next month -- potentially, a much bigger deal. The ECB will buy private asset-backed securities and covered bonds; and, Draghi said, the central bank will let the effects of those purchases expand its balance sheet. That's explicit monetary stimulus, and something of a departure for the ECB. It still isn't Federal Reserve-style quantitative easing, though, because the ECB won't be buying government bonds. This reduces the possible scale of the operation. Draghi didn't say how big the program would be, or how long it would last.
He did say this: The "aim is to steer, significantly steer, the size of our balance sheet towards the dimensions it used to have at the beginning of 2012." Does that mean all the way back, or part of the way back? You tell me. All the way back would imply a program of more than 500 billion euros. (That's substantial but not huge: Since 2008 the Fed has increased its balance sheet by more than $3 trillion.) It's unclear whether there are enough qualifying securities for a program of that size -- but then it's also unclear exactly which securities would qualify. The ECB will say more about all this next month.
Draghi's problem is partly that other members of the ECB's Governing Council -- notably Jens Weidmann, president of the Bundesbank -- don't agree that fresh monetary stimulus is needed. In itself, though, that needn't matter too much: A majority vote is sufficient, and the moves announced last week were approved by a "comfortable majority," Draghi said. The deeper issue for the ECB is that the legality of Fed-style quantitative easing is in doubt.
Draghi often implies -- as he did again this time -- that such easing could be done and remains an option. But he's forced to obfuscate. At his press conference last week, he was asked to define QE and say, in effect, whether that's what the new measures are.
On the first thing, the definition of QE is not really related to its size, but rather to its modalities. So QE is an outright purchase of assets. To give an example: rather than accepting these assets as collateral for lending, the ECB would outright purchase these assets. That's QE. It would inject money into the system. Now, QE can be private sector asset-based, or also sovereign-sector, public sector asset-based, or both. The components of today's measures are predominantly oriented to credit easing.
Possible translation: The new measures are QE, in a way, but not really the kind of QE that the ECB may possibly not be allowed to do. Or call it QE-lite. After the press conference, analysts agreed that something important had happened, but weren't sure what.
This uncertainty is damaging. It denies the central bank an instrument it needs. And, for any given deployment of unconventional measures, it blunts the force of the central bank's announcements. Case in point: Last week's trivial cut in interest rates surprised the markets and pushed the euro lower (as the ECB doubtless intended). It wasn't the size of the cuts but the force of the announcement. The cuts were unexpected because Draghi had previously suggested that rates couldn't go any lower. As a result, even tiny changes delivered important information about the ECB's reading of the situation.
If the ECB has just announced a QE program, it would be good to know. If investors were sure that's what it is, and sure that there will be more to come if need be, the policy would be more likely to work. Because it's a question of the ECB's powers, Draghi can't dispel this confusion by himself, and he should start demanding that Europe's governments do it for him. Europe's economies are in enough trouble without having to bear the costs of this incapacitating ambiguity.
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