After months of whinging and whining by the international commentariat, and of relentlessly redefining what any sensible person would call “price stability” as a grave economic problem, the ECB has caved in, as expected, and yesterday announced further stimulus measures.
I have pointed out repeatedly that low inflation is not a problem, and that the slow growth in money and credit that is presently its cause, is understandable and not entirely unhealthy. In many parts of the eurozone households, corporations, governments and banks are adjusting to post crisis conditions. Credit demand is low, which seems reasonable, and banks are preparing for the “asset quality review” by the ECB, and try and get their balance sheets in order.
In recent years the euro has been broadly stable and only appreciated slightly versus the currencies of its trading partners. This means the purchasing power of eurozone corporations and citizens on international markets has increased moderately. Import prices have declined and this has helped keep domestic consumer prices broadly stable. People on fixed income (salaries, pensions, transfer payments) have maintained their purchasing power. It is foolish to argue that such an environment “cripples” overall economic performance.
Furthermore, the line of reasoning of the advocates of easier money is logically inconsistent. If the prospect of stable prices really discourages spending, should the prospect of low and stable interest rates not also discourage borrowing? If, as the “deflationists” claim, people can only be cajoled into spending their money if they are threatened with the prospect of rising prices, do they then not have to be cajoled into borrowing by the threat of higher rates, rather then the promise of low and stable ones (“forward guidance”)? If people don’t consume if prices are not going up, will people borrow if interest rates are not going up? Should the ECB not announce an end to low interest rates soon so to encourage people to take out loans now? – The whole debate is, of course, completely absurd.
Europe has many problems. High interest rates and lack of interbank liquidity are not among them, and neither is low inflation.
The ECB and the market consensus expect growth rates of between 1 and 1.5 percent for this year and next. That seems to be close to what economists like to call “potential growth”. If people want faster growth they need to embrace structural reforms. Printing money and weakening the currency won’t do.
Before the ECB’s latest move, eurozone banks could get regular funds from the ECB at 0.25 percent, emergency funds at 0.7 percent, and they could deposit money at the ECB at 0 percent. After the ECB’s move, they can borrow regular funds at 0.15 percent, emergency funds at 0.40 percent, and they now get charged 0.1 percent for anything they keep at the ECB.
What will the impact of all of this be? – Pretty much nothing, I believe.
It is sometimes stated that the – 0.1 percent on deposits at the ECB is a fine for “parking” cash at the ECB and that it will encourage banks to do other things with the money. I think that this description is inaccurate. It gives the impression that banks could lend this money to corporations and households. But banks cannot do this.
Deposits at the central bank are bank reserves. They cannot be transferred and cannot be lent to non-banks because non-banks do not have an account at the central bank. Banks can lend these balances to other banks but the banking sector in aggregate cannot get rid of them. This means that at the new negative deposit rate the banking industry will pay about €220 million to the ECB every year and they can do precious little about it (but not to worry, this is small change in the big scheme of things).
How can this potentially be stimulating? – Individual banks that sit on large reserves may try and reduce their balances at the ECB by creating extra loans. When banks extend new loans they also create extra deposits (new money). Some of these deposits may flow to other banks, which means reserves also flow to other banks, that is, the balances at the ECB of the first bank (the credit and money creating bank) shrink. (Again, this does not lower balances at the ECB in aggregate.)
How many new and risky loans to small and medium sized companies banks will create to avoid the 0.1 percent “fine” at the ECB I do not know. My guess is it won’t be many.
The extra money injections from September onwards seem equally ridiculous to me. Banks are not lending because of some shortage of reserves or lack of interbank liquidity but out of concern for their own balance sheets and the risks inherent in extending new loans to their shaky debtors. There also appears to be limited demand for loans.
By caving in to its critics rather than vigorously defending its previously passive but reasonable policy position, the ECB nurtures the foolish belief that various monetary shenanigans could play a meaningful role in improving the European economy. These policies will not solve anything but wet the appetite for more monetary interventions down the road. The advocates of “easy money” will not be appeased for long. For these people money is always too tight, interest rates are always too high and budget deficits always too small. There is always too little “stimulus”. Paul Krugman is a case in point.
Additionally, central bankers turn ever more into central planners. The new “targeted” liquidity injections will go to banks that make the type of business loans the ECB wants them to make. I suppose banks will soon get merits and demerits according to whom they lend to. If they lend to the “real” economy they get extra cheap cash from the central bank, if they make mortgage loans they won’t. It used to be that central banks fixed short term rates in the interbank market and injected new bank reserves and left the rest, pretty much, to the market. Now they busy themselves with “asset quality reviews”, with the shape of the yield curve and credit and mortgage spreads, and with whom the banks give money to. We are seeing the steady hollowing out of the market economy and the bureaucratization and socialization of money and banking.
What does it all mean? – I don’t know (and I could, of course, be wrong) but I guess the following:
This is maybe just theatre to keep the “inflation-is-too-low” fools at bay but I suspect the ECB believes in its own importance and its own powers of “stimulus”, and that it is doing some “good work”. However, none of this should have a meaningful impact on credit metrics in the wider economy.
The impact on markets should be somewhere in the region of negligible to non-existent in my opinion.