The ECB’s decision to extend its asset purchases beyond next
March, albeit at a slower pace, is seen in some quarters as a tapering announcement
and is viewed by others as a further round of monetary easing. To recap, the
ECB announced that it will extend its asset purchases to December 2017, rather
than end in March, but at a rate of €60bn per month rather than the current
pace of €80bn. Technically, a reduced pace of asset purchases is a form of tapering.
But let us not forget that when the ECB began its purchases last year, it was initially
buying at a monthly rate of €60bn. I am inclined to view the announcement this
week as continued monetary expansion rather than a precursor of tapering.
Looking more closely at the statement issued by the ECB (here) the presumption is that it will have to do more rather than less. Purchases will continue to December 2017 “or beyond, if necessary” and “if … the outlook becomes less favourable … the Governing Council intends to increase the programme in terms of size and/or duration.” Nowhere does it say that the central bank will scale back purchases if the outlook improves or if inflation picks up more quickly than anticipated. In that sense, it is an asymmetric commitment.
Increasingly, I get the sense that the ECB is out of step. It came late to the QE party, beginning asset purchases only in 2015 whereas the Fed and BoE started in 2009. The Fed has long since ended its asset purchase programme, and the BoE announced only a modest expansion in August in the wake of the EU referendum, having been on hold for much of the preceding four years. There is also clear evidence that the bang for the buck (or euro) diminishes the more QE is undertaken. Indeed, the BIS made precisely this point in its 2016 Annual Report (here, see p72). As it pointed out, “there are natural limits … to how far interest rates can be pushed into negative territory, central bank balance sheets expanded, spreads compressed and asset prices boosted. And there are limits to how far spending can be brought forward from the future. As these limits are approached, the marginal effect of policy tends to decline, and any side effects – whether strictly economic or of a political economy nature – tend to rise.”
The problem is not all of the ECB’s doing. Successive Presidents have been making the point since the ECB’s inception in 1999 that governments need to do more to reform their economies. And they simply have not done so. This mirrors comments by BoE Governor Carney who made a similar point regarding the UK (as I noted here). But the need for reform is far more acute in the euro zone. In a fixed exchange rate system, the burden of adjustment for economic problems falls squarely on the domestic labour market; No longer can countries rely on a weaker exchange rate to bail them out. Italy is a case in point, where the economy has barely grown in the last 16 years, and where politicians have been frustrated in their efforts to reform the domestic economy by groups with a vested interest in preserving the status quo (notably the unions). Whilst you have to feel a bit sorry for well-meaning politicians such as Matteo Renzi, it is hardly a surprise when electorates turn on their politicians as the Italians did last weekend in the constitutional reform referendum.
However, there is growing concern in Germany that the euro zone is morphing into a transfer union, as surplus countries continue to prop up the ailing southern peripherals. Technically, this is true. But this is also a necessary condition for the euro zone to survive. Not all countries can run external surpluses, and they certainly cannot all run surpluses against each other. In the absence of these transfers, the euro zone is just another fixed currency regime which will inevitably fall apart. Suggestions last week from German Finance Minister Wolfgang Schäuble that Greece must carry out structural reforms instead of receiving debt relief are to entirely miss the point about the nature of the problems which it faces. Greece is labouring under such a huge debt burden (182% of GDP) that unless part of it is written off, it will simply default. Period! And most people know it.
ECB President Draghi may be pilloried for running a policy which appears to benefit “profligate” southern European countries, but he is stepping into the void created by politicians who are not doing anything to support the economy via fiscal policy or structural reform. Without his efforts, the euro zone would be in an even sorrier state. But as the BIS analysis suggests, economies cannot live on monetary policy alone. And all this does raise genuine existential concerns for the future of the euro zone. We used to talk of Grexit long before we had even heard of Brexit but all the problems which the region has dealt with in the last seven years are still there. The beatings will continue until morale improves.
Looking more closely at the statement issued by the ECB (here) the presumption is that it will have to do more rather than less. Purchases will continue to December 2017 “or beyond, if necessary” and “if … the outlook becomes less favourable … the Governing Council intends to increase the programme in terms of size and/or duration.” Nowhere does it say that the central bank will scale back purchases if the outlook improves or if inflation picks up more quickly than anticipated. In that sense, it is an asymmetric commitment.
Increasingly, I get the sense that the ECB is out of step. It came late to the QE party, beginning asset purchases only in 2015 whereas the Fed and BoE started in 2009. The Fed has long since ended its asset purchase programme, and the BoE announced only a modest expansion in August in the wake of the EU referendum, having been on hold for much of the preceding four years. There is also clear evidence that the bang for the buck (or euro) diminishes the more QE is undertaken. Indeed, the BIS made precisely this point in its 2016 Annual Report (here, see p72). As it pointed out, “there are natural limits … to how far interest rates can be pushed into negative territory, central bank balance sheets expanded, spreads compressed and asset prices boosted. And there are limits to how far spending can be brought forward from the future. As these limits are approached, the marginal effect of policy tends to decline, and any side effects – whether strictly economic or of a political economy nature – tend to rise.”
The problem is not all of the ECB’s doing. Successive Presidents have been making the point since the ECB’s inception in 1999 that governments need to do more to reform their economies. And they simply have not done so. This mirrors comments by BoE Governor Carney who made a similar point regarding the UK (as I noted here). But the need for reform is far more acute in the euro zone. In a fixed exchange rate system, the burden of adjustment for economic problems falls squarely on the domestic labour market; No longer can countries rely on a weaker exchange rate to bail them out. Italy is a case in point, where the economy has barely grown in the last 16 years, and where politicians have been frustrated in their efforts to reform the domestic economy by groups with a vested interest in preserving the status quo (notably the unions). Whilst you have to feel a bit sorry for well-meaning politicians such as Matteo Renzi, it is hardly a surprise when electorates turn on their politicians as the Italians did last weekend in the constitutional reform referendum.
However, there is growing concern in Germany that the euro zone is morphing into a transfer union, as surplus countries continue to prop up the ailing southern peripherals. Technically, this is true. But this is also a necessary condition for the euro zone to survive. Not all countries can run external surpluses, and they certainly cannot all run surpluses against each other. In the absence of these transfers, the euro zone is just another fixed currency regime which will inevitably fall apart. Suggestions last week from German Finance Minister Wolfgang Schäuble that Greece must carry out structural reforms instead of receiving debt relief are to entirely miss the point about the nature of the problems which it faces. Greece is labouring under such a huge debt burden (182% of GDP) that unless part of it is written off, it will simply default. Period! And most people know it.
ECB President Draghi may be pilloried for running a policy which appears to benefit “profligate” southern European countries, but he is stepping into the void created by politicians who are not doing anything to support the economy via fiscal policy or structural reform. Without his efforts, the euro zone would be in an even sorrier state. But as the BIS analysis suggests, economies cannot live on monetary policy alone. And all this does raise genuine existential concerns for the future of the euro zone. We used to talk of Grexit long before we had even heard of Brexit but all the problems which the region has dealt with in the last seven years are still there. The beatings will continue until morale improves.
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