The ECB Can't Risk a Taper Tantrum
With inflation in the euro zone starting to show signs of life, European Central Bank watchers are beginning to speculate about when quantitative easing might taper off. Germany's Bundesbank, which has been uncomfortable with the bond-buying program from the get-go, is likely to be a leading advocate of scaling back purchases. But there are significant risks to moving too soon.
The ECB isn't expected to announce any changes tomorrow after its regular policy meeting. But Mario Draghi is likely to face some tough questions in the press conference, particularly on the topic of whether the central bank is poised to begin tapering its efforts.
Getting out of QE promises to be as politically contentious as getting into it was. I suspect that the coming fight about tapering will turn into a proxy battle about the ECB's inflation target. The doves will mount a spirited defense against any efforts to scale back QE; the hawks are playing a longer game, and see tapering as a way to ultimately force through a reduction in the consumer price yardstick. The longer 2 percent continues to be an unreachable goal, the stronger the argument for a lower target -- something the Bundesbank has desired from the very beginning of the single-currency project.
"An exit from the QE policy is more and more difficult, as the consequences potentially could be disastrous," Otmar Issing, who was the ECB's first chief economist and is now president of the Center for Financial Studies, said in an interview published by Central Banking magazine last week.
Consumer prices in the euro region rose 0.4 percent in September, the fastest pace since late 2014 as higher oil prices fed into energy costs. In Germany, however, the key inflation measure is accelerating at an annual pace of 0.5 percent; economist are forecasting that will double by the end of the year, and speed up into 2017. That's making German officials even less patient with the ECB's policy of buying 80 billion euros of debt ($88 billion) each month.
Nonetheless, it would be a mistake for Germany to push for early tapering at this point. Economists expect euro-region consumer prices to rise by just 0.2 percent this year, far below the ECB's 2 percent target, and the consensus forecast for next year is just 1.3 percent.
There's a risk that slowing the stimulus efforts would trigger a relapse in inflation, requiring a restart. A prolonged, bumpy and de-stabilizing exit from QE clearly is not in Germany’s interests. The threat of deflation may also reappear if the central bank's monthly asset purchases are curbed by too much.
The best way to achieve a smooth, continuous exit from QE is for the taper to proceed in small decrements over an extended time period. That’s how doctors get their patients off steroids; slowly, but steadily.
Of course, an inflation relapse might be what some Germans want. Those who see hyperinflation as always a clear and present danger have never been comfortable with the 2 percent target set for the central bank.
Lowering the inflation target would be popular with German savers because it raises the real interest rate. But higher real borrowing costs could undermine the economy by causing firms operating in Germany (and elsewhere in the euro region) to cut back on investments, output and employment. German wages would suffer. Why should German workers, business and the economic recovery be put at risk for the benefit of German savers?
Moreover, changing the ECB's inflation mandate would put dangerous stress on the solidarity of an already fractured monetary union. The current target is more than a political compromise; it is an implicit contract between debtor and creditor partners. Changing it has tricky economic implications for both sides.
Germany is a creditor nation while the southern-tier countries are debtors. Lowering the inflation target helps redistribute income from debtors to creditors in the years ahead. But it isn't in Germany's interests to make it harder for the debtor nations to meet their obligations.
Central bank hawks and doves alike must guard against intemperate and rancorous disputes over monetary policy that could stoke the populist sentiment that's seen a rise in popularity of parties including the AfD in Germany and the National Front in France. A public fight among ECB members about their QE exit strategy would be damaging, and not only for the central bank's credibility: it could threaten the future of the single-currency project itself.
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