Mario Draghi's Impossible Task

Spare a thought for Mario.

Photographer: DANIEL ROLAND/AFP/Getty Images

Managing expectations is at least nine-tenths of effective monetary policy, so in that sense, European Central Bank President Mario Draghi failed on Thursday. At the same time, don't be too hard on the guy: He's being asked to do the impossible.

Draghi's announcement of additional monetary stimulus was less than what investors had been led to expect, and afterward the euro strengthened and European stock indexes fell. Both are bad for demand and aren't what the ECB intended.

Europe's main problem is indeed lack of demand -- its recovery is still agonizingly slow, and inflation continues to run far below the ECB's target of less than but close to 2 percent -- but under current conditions there's only so much the central bank can do about it.

Europe's QE Quandary

The ECB had already pushed its benchmark interest rates about as low as they can go. The rate that now matters most, on banks' reserves at the central bank, was already slightly negative. Draghi announced that it would be cut by another sliver, to minus 0.3 percent.

He also said the ECB would extend its quantitative easing program by another six months, at least until March 2017; reinvest the proceeds, as those holdings mature, in further bond purchases; and broaden the pool of bonds eligible for the program. This amounts to a commitment to keep the ECB's balance sheet bigger, and for longer, than previously announced.

What more could he have done? Many investors had expected an increase in the rate of purchases, currently 60 billion euros a month. And the penalty rate on reserves could have been pushed to minus 0.4 percent instead of 0.3 percent. Yet those changes, which the ECB could resort to later if inflation fails to pick up, might not make much difference in themselves. The ECB's main error was not in doing too little, but in leading investors to expect more than it chose to deliver.

Yet spare a thought for the difficulty Draghi faces. The ECB is split. Some of its members think the stimulus has already gone too far. Draghi said the governing council was not unanimous in supporting the announcement. Presenting a clear and consistent message -- the sine qua non of effective monetary policy -- isn't easy when the central bank is itself uncertain over how to proceed.

And that uncertainty is understandable, because monetary policy is pushing against the limits of what it can plausibly achieve.

As much as it could, QE has worked. Credit conditions in the euro area have improved: Loans are cheaper and easier to get than if the program hadn't been undertaken. The continuing threat of deflation justifies the ECB's further measures -- but the central bank can't solve this problem by itself. Europe's governments need to revisit their fiscal policies. The European Union needs fresh stimulus in the form of public investment. It must turn to structural reform with far greater urgency. Macroeconomic coordination -- except in monetary policy -- has been almost entirely absent.

Easy money is part of the remedy for what ails Europe's economy -- but only part. Demand won't recover until confidence returns. That will require stronger and more purposeful direction from Europe's governments.

Have Draghi's QE Measures Done Enough to Impress?

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