The spectacular increased volatility in several sectors of the financial markets (FX, equities, bonds) during and in the aftermath of President Draghi’s press conference on March 10th, during which he presented Urbi and Orbi the decisions of the ECB’s Governing Council, demonstrates the difficulties of undertaking such a communication exercise. Like Saint Peter leaving his fishing boat, Super Mario executed a high wire act creating the illusion that he “walks on water”, hoping to maintain markets in a state of levitation until such time – so far differed – when the real economy will provide him with a firm footing.
The President was aiming to convey several messages: that the ECB was not giving up on its objective of stimulating the Eurozone economy within the framework of its price stability mandate; that it was not short of ammunition to carry out its monetary policy and that, for the foreseeable future, unconventional monetary policies would supersede interest rate policies. He was thus confirming that his 2012 commitment to “do whatever it takes to support the €” remained intact.
The opinion that the measures are significant is broadly shared, but the consensus as to their efficacy is far more fragile. Are most of us, like Saint Peter, «men of little faith”? The complexity of monetary policy transmission mechanisms and the incidence of external factors which escape the control of the ECB make any direct correlation between the measures taken and the anticipated results extremely hazardous.
Neither was the press conference exempt of ambiguities:
Mario Draghi offered a very defensive argument as a justification for the Bank’s decisions: “If we had failed to act, we would have been accused of increasing the risks of deflation which would have been particularly penalising for debtors”. How then is it possible to reconcile simultaneously debt deleveraging and credit stimulation to support economic activity? Resolving this conundrum is particularly difficult within the Eurozone because budgetary and fiscal sovereignty, retained by Member States, makes targeting specific monetary policy measures, meant to be applied uniformly throughout the zone, far more complicated.
Let us now consider the expected impact of increasing by € 20 billion, the monthly creation of additional liquidity. The beneficiaries should be in part the treasuries of EMU Member States. The positive impact on the economy will only be felt in the long term to the extent the proceeds are directed to productive investments (infrastructure, etc.) rather than to shoring up current budget deficits. Implementing further structural reforms is a necessary condition to give the bold ECB’s monetary policy any chance of succeeding. One can doubt that, over the short term, the expanded quantitative easing will lead to a positive impact from government spending other than through the illusion of temporary lower debt servicing costs.
As far as the purchase of corporate bonds is concerned, it should prove positive if it leads to increased borrowing for investment rather than to refinancing outstanding debt at lower cost or accelerating stock repurchase programs, the latter being at present the favoured route to boost earnings per share. The fact that credit demand is weak (due to the poor economic environment) rather than a shortage of the credit availability (due to the plethoric liquidity) does not bode well as far as the success of the proposed new measures.
The increase in quantitative easing should contribute to banking profits derived from their intermediation between issuers and the ECB. These operations carry little risk as long as the massive monthly purchases continue to provide a downward bias to interest rates as well as an opportunity to liquidate rapidly short term speculative positions but they do not contribute to fostering growth.
Nevertheless, it is probably the new offer of LTROs (long term refinancing operations) that offers the best chance of stimulating credit demand, in particular through the novel mechanism of interest rate subsidies which will improve the spreads earned on new loans to the real economy. Their success will remain subject to the capacity of each bank to adapt to the new prudential regulatory framework aiming at improving risk management.
The ECB has mobilized an impressive arsenal of measures – “the big bazooka” – aimed at reversing prevailing pessimism and providing a boost to the timid recovery. This salvo could, however, amount to a mere “damp squib” if Member States failed to face up squarely their own responsibilities relying, once again, exclusively on the ECB’s monetary policy to carry the burden of unpopular measures needed to restore growth.
Some commentators believe that facing a new existential crisis, the Eurozone and the Union will pull themselves together by “necessity” thus avoiding the disintegration of the European project; they rely on past examples in which dire need created the necessary impulse and political will to overcome apparently insoluble challenges and eliminate ideological blockages. If such an optimistic scenario is highly desirable and should not be rejected out of hand, one should, however, worry that many factors escape the control of Authorities, in particular once initiated a chain of events that are difficult to reverse. Examples might include a deepening of the immigration crisis that would threaten the survival of the Schengen zone and compromise the workings of the single market or, alternatively, a new economic and financial crisis originating either within or outside of the Union, and for which the Eurozone remains ill prepared having postponed for too long the completion of EMU.
In conclusion, Member States cannot just rely on hope, in the belief that a new crisis will necessarily offer the opportunity to relaunch successfully the European project.
Brussels 14th March 2016
Paul N. Goldschmidt
Director, European Commission (ret.); Member of the Steering Committee of the Thomas More Institute.
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