When Mario Draghi first launched the European Central Bank’s bond-purchasing program this spring, he was in a celebratory mood. Given the billion-dollar volume, markets responded positively to the move: The central bank had passed the credibility test.
Now, less than eight months later, it seems that Mr. Draghi himself hardly believes in the cash injection plan. The ECB chief is said to already be considering extending the program.
Mr. Draghi’s announcement last Thursday that the central bank is working on new solution has put the ECB on track for an expansion of the money flood at its next governing council meeting in December. And he went even further when he suggested the possibility of lowering of the ECB’s penalty rate for banks that park their reserves at the central bank (it’s currently minus 0.2 percent).
Instead of leading the euro zone deeper into an economic world of illusion, Mr. Draghi and the ECB need to go back to a belief in the healing power of the markets.
Mr. Draghi’s words once again did not fail to have an effect. The stock market cheered, the euro fell and government bond yields sank – two-year bonds are consistently negative in much of the 19-nation euro zone. Thanks to Mr. Draghi, investors are now looking to debt-ridden Italy, whose government bonds may be a more attractive option in the short term.
So, Mr. Draghi has paved the way for the hoped-for year-end stock market party. But at what cost?
The collateral damage of his announcement is enormous: The frantic activism with which the ECB responded to news that the euro zone fell back into negative inflation in September damages the much-vaunted credibility of the central bank. If they actually increase the volume of monthly bond purchases from the current €60 billion, it primarily signals that the strategy has been a lot less efficient than anticipated.
As Mr. Draghi opens one monetary floodgate after another, his approach resembles more and more the kind of medicine that becomes less effective with increased use. With ever shorter intervals, the ECB boss has to offer up one carrot or another to keep the markets happy.
Just look at the euro, whose exchange rate with the U.S. dollar fell sharply after the announcement of the planned bond-buying program in January, but has largely trended sideways since quantitative easing actually began in March.
Mr. Draghi's actions have neither helped to appreciably kick-started the eurozone economy, nor have they raised inflation as desired.
While Mr. Draghi’s words may be magical, his actions are not. They have neither helped to appreciably kick-started the eurozone economy, nor have they raised inflation as desired. Instead, they have done massive, possibly irreparable damage to the European economy.
Despite low interest rates, the flood of money has not increased companies’ desire to invest. Instead, that preparedness has fallen because market interventions have led to high volatility on the markets and uncertainty in the real economy.
But above all, “Super Mario” has turned normal market mechanisms upside down. Companies with bad credit ratings pay low premiums compared to less risky companies, due to the system pressures created by the influx of cash from central banks.
The same things can be seen in the individual countries. Italy, with all its debt, pays less than one percentage point in interest more than the far more solid Germany. The ECB’s monetary policy leads to zombie companies and zombie countries with insurmountable debt loads that only appear to be unproblematic.
The central bank says its policies will buy time for structural reforms by governments in individual countries to be put in place, but this is difficult to understand. Indeed, despite some progress – for example with Matteo Renzi’s government in Italy – there is too little happening overall in the euro zone. If the interest rates weren’t being artificially depressed, there would certainly be much greater impetus and pressure for change.
Instead of leading the euro zone deeper into an economic world of illusion with further monetary easing, Mr. Draghi and the ECB need to go back to a belief in the healing power of the markets.
This is especially true since the effectiveness of an extension or increase in the bond purchasing program remains doubtful – after all, interest rates are already at record lows. Even more dangerous would be an increase in the penalty rate. This would cause serious damage to the European banking system.
In short, it’s time to stop the monetary expansion. The risks and side effects are just too great. Otherwise, the second half of Mr. Draghi’s eight-year term looks set to start off headed in the wrong direction. These could be the years that go down in history as those in which the ECB lost its credibility.
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