Mario Draghi, President of the European Central Bank, on his way to a press conference following a meeting of the governing council in Frankfurt, Germany, 10th March 2016. ©Michael Probst/AP/Press Association Images
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Ahead of today's European Central Bank meeting, it was expected that to stir the eurozone's economy the Bank would have to announce strong measures. In the event, it went even further, and threw the kitchen sink at the eurozone. But apparently, this has had little effect.
So what did the ECB announce that was so substantial? For starters, The negative interest rate on the Bank's main deposit facility was lowered from -30 to -40 basis points. This is what other banks are charged to hold deposits at the ECB.
It will also introduce four targeted long-term refinancing operation facilities with a maturity of four years. These are loans to banks to help them bolster liquidity. Draghi also said that for banks whose net lending exceeded a certain benchmark, the interest rate charged on these loans could be as low as on the deposit rate facility. In other words the ECB will, under some circumstances, pay banks to take the loans in order to on-lend the proceeds. In effect, anyway.
In truth, bank shares did perk up smartly after the announcement, and European stock markets rallied as they always do if the central bank is throwing liquidity around. But one hallmark of a successful move from the ECB would have been a sharp fall in the euro, which happened initially but then promptly reversed itself. A more telling sign still that the ECB was on to something would have been a significant rise in German bond yields and the bond yields of other countries. This has always been the litmus test of whether the bank's polices will gain traction. Today, they again did no such thing. The reasoning is simply that if unorthodox monetary policies were thought likely to have their desired effects, investors should sell bonds in anticipation of higher inflation and economic growth.
Whether any of the banks measures will work in the long-run is debatable. By way of background, the ECB has lowered its growth forecast for the euro area from 1.7 to 1.4 per cent for this year, and more significantly lowered its inflation projections to 0.1 per cent for 2016, and to 1.3 and 1.6 per cent for 2017, and 2018 respectively. In February of this year, inflation was 0.2 per cent lower than a year before, while core inflation, stripping out energy prices, was 0.7 per cent higher. But the ECB’s target, its only target, is inflation of below but close to 2 per cent. The test of the ECB’s strategy, then, is whether it can hit that target over the medium-term, and give companies the confidence to invest and give workers a case for demanding higher wages.
The empirical evidence we have to date shows that asset purchases under QE help to push up asset prices, which makes the rich feel richer and helps banks’s balance sheets to look stronger. It drives down borrowing costs, and there’s no question that the ECB can create the cash that banks might lend.
But the central bank can’t force households and companies to borrow to spend and invest. At the same time, there is a rising chorus of concern—not least at the Bank for International Settlements, the central banks’s central bank—that this whole experiment with negative interest rates is counter-productive. Sweden, Denmark, Switzerland and Japan are also pursuing negative interest rate policies. Negative rates are thought to be damaging to bank business models and profitability, to agents in the loan books of shrinking banks, and to cross-border lending, when the whole idea of unorthodox monetary policies is to get banks to lend.
It almost goes without saying that the ECB has no capacity to change anything when it comes to the economic problems that lie behind the eurozone's economic and deflationary ailments. These include the issues of free movement, immigration management, productivity, debt restructuring, public investment, labour market and service sector reforms and competitiveness. These all lie firmly within the operational sphere of governments, not the ECB.
So is the ECB’s arsenal now bare? If it sticks to the general approach to policy it has currently then yes. But, though this is inconceivable as thing stand, there are things the ECB could theoretically do. It could take us towards Milton Friedman's "helicopter money." This would involve the ECB taking a more direct role in creating money that might be distributed directly to households, companies and banks, for example by buying loans from banks, or public debt directly from governments, or financing cash distributions in the form of tax cuts or investment allowances.
These ideas will remain the subject of idle chatter for the time being. But eventually, who knows? If today’s kitchen sink episode ends with a whimper, as seems likely, and governments continue to stand aside from the economic fray, Europeans may demand still more of their central bank.
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