ECB Woes

Of Hawks and Protectionists

ARCHIV - Der Neubau der Europäischen Zentralbank (EZB) scheint am 21.10.2014 in Frankfurt am Main (Hessen) die Skyline der Stadt beim Blick aus Offenbach zu überragen. Foto: Frank Rumpenhorst/dpa (zu dpa "Europäische Zentralbank erhöht Strafzins für Bankeinlagen" vom 03.12.2015) +++(c) dpa - Bildfunk+++
Not much cause for optimism? 
  • Why it matters

    Why it matters

    The biggest threat to the ECB and the euro zone is not Mario Draghi’s monetary policy, but in-fighting within the institution, the writer says.

  • Facts

    Facts

    • The ECB’s official inflation goal is at just under 2 percent.
    • A group of hawkish central bankers want to push this target even lower.
    • Falling oil prices and sluggish global growth are creating a deflationary environment in Europe.
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  • Audio

    Audio

  • Pdf

As we enter 2016, Mario Draghi’s prediction that the European Central Bank will achieve its inflation target of just under 2 percent is being met with increasing skepticism — and for good reason.

Euro zone inflation is way below target and judging from the meager stimulus package agreed to by the bank’s governing council at its December meeting, Europe’s central bank does not appear to be in any particular hurry to correct the situation.

That’s playing with fire. The perception of indifference on the part of the central bank to its inflation target increases the danger that under the weight of plunging crude oil prices and fragile global demand, euro zone markets develop a deflationary mindset or bias that turns current sluggish inflation into actual deflation.

New euro zone monetary stimulus is needed precisely to prevent this from happening.

The ‘hawks,’ led by the German Bundesbank, are engaged in a kind of guerrilla warfare to lower the inflation target rate.

The ECB’s problem is not Mario Draghi, who has shown by words and deeds that he is willing to do unpopular and unconventional things to boost inflation — but the bank’s governing council, a body racked by special interests and divergent agendas.

The hawks on the board, led by the German Bundesbank, are engaged in a kind of guerrilla warfare to lower the inflation target rate from slightly below 2 percent to a much lower figure.

They always come up with ‘socially acceptable’ reasons for their opposition to new easing — like previous easing measures need more time to work out their effects…and so on — but their bottom line is that the lower inflation goes the better they like it.

Dutch hawk and ex-council member Nout Wellink let the cat out of the bag in a newspaper interview after his retirement when he claimed that there was nothing wrong and even a lot right with deflation. Mr. Wellink claims deflation boosts consumption.

That’s bad economics — yet that’s what ECB hawks really believe even as they swear false allegiance to the 2 percent inflation target.

For a long time the hawks were the center of resistance to monetary stimulation in the governing council but lately, with the growing importance of the deposit rate in the ECB’s toolbox, they have been joined in their opposition to monetary stimulation by a group I call ‘bank protectionists.’

These are national central banks like the Banque de France that seek to protect bank profits regardless of the consequences for ECB credibility in reaching its inflation target — and see cuts in the already negative deposit rate as taxes on bank profits.

At the December meeting the bank protectionists were able to keep the cut in the deposit rate to a meager ten basis points even though they knew it would mean an increase in the euro and a setback for ECB credibility. They just didn’t care.

Because cutting the deposit rate has become the most effective weapon the ECB has in its arsenal for getting the euro down without engaging in an all-out currency war with its trading partners, the bank protectionists have emerged as an even bigger threat to the inflation target and ECB credibility than the hawks whose leader Bundesbank President Jens Weidmann is widely viewed to have lost influence and cache.

Who wins the battle between the bank protectionists and the ECB top leadership in 2016 over further deposit rate cuts will go a long way in determining the fate of ECB credibility in 2016. If the ECB becomes unable to use — or sufficiently use — one of its most potent weapons to fight sluggish inflation, ECB credibility will suffer a significant blow.

You can lead a horse to water but you can’t make it drink. To many in the markets what happened at the December meeting was that Mr. Draghi was doing the leading while the governing council refused to drink.

That kind of division at the central bank is toxic to markets. Unless the ECB’s top leadership and the rest of the governing council are seen as being on the same page, Mr. Draghi’s prediction that the ECB will achieve its current inflation target over the next years will prove wildly optimistic.  

 

To contact the author: gastautor@handelsblatt.com.

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