With its latest decisions, the European Central Bank has added yet another element to its strategic shift. The reorientation of the ECB’s monetary policy has been expedited as part of its crisis management since late 2011. The central bank has garnered praise and recognition for its efforts.
What is being overlooked is the fundamental distortion in market conditions caused by the ECB’s policies. The necessary correction, whenever it happens, could lead to another serious crisis.
To be legitimate, a decision-making process on monetary policy requires that the following questions be addressed: 1. Do the measures produce the desired outcome within the framework of the mandate? 2. Can unwanted side effects be accepted as a necessary evil? 3. Is a trouble-free exit from the approved measures possible?
In light of the latest decisions by the ECB Governing Council, all three questions can be answered in the negative. The reduction in the benchmark interest rate by 0.1 percentage points to 0.05 percent would be laughable if the situation were not as serious as it is. It could be dismissed as symbolic if it didn’t represent the first time the ECB has pursued an exchange rate objective and the targeted weakening of the euro exchange rate, a goal French and Italian politicians repeatedly stress.
However, near-zero interest rates will not produce a single euro in additional lending, and in the longer term this lack of effectiveness will further undermine the ECB’s reputation, among other adverse effects. Nevertheless, shortsighted financial markets and European politicians are welcoming the decisions: The president of the ECB has “kept his word.” In fact, he has even delivered more than expected.
The decisions taken in June 2014 to make additional, long-term liquidity (until 2018) available to banks, along with the most recent decision to have the ECB buy up asset-backed securities, or ABSs, from the banks, will expand the balance sheet of the Eurosystem – the network of central banks governing Europe – by an estimated €1 trillion ($1.29 trillion), or about 50 percent. In other words, markets will be flooded with additional liquidity at a time when there is already excess liquidity worldwide.
The negative side effects, in the medium term, of pursuing an overly lax monetary policy for too long are undeniable. The Bank for International Settlements (BIS) in Basel, Switzerland, has been pointing out this problem for years.
The new measures are, in particular, a reaction to the political desires and demands of France and Italy,.
What does the ECB hope to achieve with the measures approved in June 2014 and last week? After all, prices are stable in the euro zone.
No one, not even the ECB, is talking about the advantages of stable price levels anymore. Instead, the focus is on the adverse effects of an excessively low rate of inflation on debt-ridden countries. But the truth is that these countries “profit” from the extremely low interest rates on their bonds, which in some cases are even negative. Given the amount of accumulated sovereign debt, significantly higher interest rates would lead to collapse in some countries.
What prompted the ECB to take these decisions?
Financial market players, international institutions and the ECB itself are particularly concerned about the possibility of deflation in the euro zone. Another and probably more critical reason is to buy even more time for necessary structural reforms in those euro zone countries that are still lagging behind in making the necessary adjustments.
The new measures are, in particular, a reaction to the political desires and demands of France and Italy, namely that in addition to an easing of budgetary targets in the context of the European Union’s Stability Pact, the ECB should also pursue a more expansive policy, which also includes a weaker euro exchange rate.
But these demands are coming from countries that shy away from serious reforms, or that either cannot or will not implement reforms. For this reason, the latest decisions are also a reflection – neither unexpected nor unsurprising – of the composition of the ECB Governing Council and national political pressure.
The scope of bad loans in Italy, Spain, Ireland and Greece is considerable, and it is the real reason behind stagnating loan development. But individual governments need to intervene here and find a solution. Banks must be relieved of bad loans, suitably recapitalized or liquidated.
This is not the central bank’s job. But by taking this on, and relieving the burden on the banks with its ABS purchase program, it is pursuing a country-specific policy. It is clearly and deliberately blurring the powers of governments and the central bank. Moreover, by purchasing ABSs, regardless of their quality, the ECB is adding enormous risks to its balance sheet and turning itself into a European bad bank. This is a term that I have felt was unwarranted for the ECB until now.
With this new role, the ECB is creating a new element of shared liability in the euro zone. In the end, the taxpayers in member states are liable for any losses. The potential redistribution effects would be enormous. Because it is not democratically elected, the ECB Governing Council does not have the authority to take decisions with such far-reaching consequences.
The latest statements by ECB President Mario Draghi at the August Jackson Hole conference in the United States, along with the ECB council’s decisions, signify a shift in its monetary policy strategy.
The ECB’s monetary policy is now oriented less toward the euro zone as a whole than towards the economic problems of individual countries. It abandoned efforts to achieve uniform monetary policy in the currency zone long ago.
It is a short-term strategy and no longer geared toward the medium term. Although the ECB mandate is repeatedly emphasized when new decisions are communicated, the whole thing borders on hypocrisy. The ECB is effectively no longer operating within its narrow mandate.
When considered together, the June and early September decisions, with the reduction in the basic interest rate to 0.05 percent, tying long-term liquidity allocation to bank lending and the purchase of ABSs, make the conflict of interest between monetary policy and bank regulation – a new ECB task – more and more apparent. Financial stability and regulatory issues already dominate monetary policy today.
Until well into 2011, there was a consensus that the ECB had done everything it could to combat the crisis, and had already expanded its mandate to an extreme at the time. Everything else was up to the individual governments. The pressure on international and national policy was maintained.
The transformation in the last three years occurred gradually, and it led to a calming of the financial markets. However, none of the structural problems have been resolved, especially not in France and Italy, two large member states. Unemployment and government debt remain unacceptably high, and there is no improvement in sight. The solution cannot be to take on even more debt. And monetary policy cannot solve these structural problems. It is already stretched too thinly today.
The ECB has taken on a mandate for financial stability, and it will soon assume the task of regulating banks. Starting in 2015, the voting rights of national central bank governors will rotate and the number of monetary policy meetings of the ECB Council will be reduced, at a time when the crisis is far from over.
The days of intensive intellectual debate over the challenges of monetary policy, a pronounced team spirit within the ECB council and unanimous decisions on fundamental issues or in a “broad” consensus are finally over. The ECB used to accomplish these things, at least until early 2010.
Today’s ECB has little in common with the ECB at the time of its founding.
“The ECB has discarded virtually all restrictions of the Maastricht Treaty, which had tied the bank to the model of the German Bundesbank,” Alan Greenspan has said.
Many people approve of this. But this “success” will come at a high economic and political price.
Jürgen Stark was chief economist at the European Central Bank from 2006 to 2012, until he announced his decision to resign “for personal reasons” in September 2011. Mr. Stark later said that he had been unwilling to support the ECB’s approach to rescuing Greece.
This article was translated by Christopher Sultan. To contact the author: firstname.lastname@example.org