Daily Commentary: The ECB’s move toward monetisation
The ECB’s forward guidance last week was begun with unanimous support including the German contingent. I think this is a very significant development in the European sovereign debt crisis because it moves the ECB that much closer to full blown monetisation. A few brief comments below
I first discussed “rate easing” in November 2010 in response to reports that the FOMC considered offering unlimited quantitative easing to target long-term interest rates. At the time I had this to say about QE2:
The first round of QE was somewhat defensible as a measure to provide lender of last resort liquidity. This round is different. I do not advocate more QE. Nevertheless, my view is that QE will be ineffective in large part because the Fed has not taken any of the three more draconian measures I highlighted above. Moreover, QE has been that much more destructive because it has damaged America’s negotiating position abroad and made the Fed a lightening rod of criticism. Meanwhile, Ben Bernanke continues to argue that QE will create jobs when all indications are that it will not – unless they are willing to target interest rates lower with an unlimited supply of liquidity. Then, and only then, would we have to worry about inflation from the huge amounts of money sloshing around the system.
I would still contend today that all of the Fed’s quantity-based easing measures have been mostly ineffective, especially in the wake of a large private sector debt crisis. But the Fed did begin “rate easing” with its third easing campaign in August 2011.
Now, rate easing is where, instead of simply offering up quantity targets for asset purchases, the Fed actively targets a longer-term policy rate. Forward guidance is a soft form of this. QE1 and QE2 were pure quantity-based easing measures. But beginning in August 2011, the Fed began to supplement its quantity-based easing measures with price-based measures, which are more effective in lowering interest rates.
Now the ECB has moved into rate easing mode with its own forward guidance. By offering forward guidance on policy rates, the central bank anchors investor expectations for future interest rates and takes a much more direct influence over longer rates. Effectively, the central bank is saying, low short-term rates are not enough stimulus. We need lower long-term rates as well. And so we will try to lower them by telegraphing much more explicitly what the future path of policy rates will look like.
The ECB can couch this move in terms of the need to offer easier economic conditions. However, the most direct beneficiary of lower rates are government debtors in the eurozone as the forward guidance effectively lowers the risk free rate in the euro zone. In essence, the ECB is one step short of actively monetizing euro area government debt – and this is being done with the explicit approval of all members of the German monetary policy elite!
What this tells me is that the ECB is very concerned about the state of the economy in Europe and is willing to go to extra lengths to prevent a nasty debt deflation from expanding to the core. Germany is at risk of recession while France, Finland and the Netherlands are already in recession. Now the austerity yoke has been partially removed by backloading the measures. And the ECB has upped the ante by moving into rate easing territory. This policy stance will give the euro zone some breathing room and I expect the economy there to recover by sometime later this year. For now, I am concentrating on this facet. There are unintended consequences that we can discuss later.
Today’s links are below.
“Japanese women are seeking men who invest in government bonds, according to an advertisement being run by the Ministry of Finance.
“I want my future husband to be diligent about money,” a 27-year-old woman says in an ad being run in free magazines promoting a fixed-rate, three-year note that Japan started selling last week. “Playboys are no good.” She’s one of five women featured in the page, which says “Men who hold JGBs are popular with women!!” “
“China is in the midst of a classic credit bubble. The ratio of total credit to gross domestic product has risen from around 115 per cent in 2008 to an estimated 173 per cent, an acceleration in credit expansion that has spelt danger in many other economies. Much of this has come in the poorly regulated shadow banking sector, where the annual rate of credit expansion exceeds 50 per cent. The Chinese authorities are signalling, correctly, that this must slow sharply.”
When you read this, the first thing that comes to mind is the euro. How is being in the euro good for Greece? If they had left the eurozone, would life have been any worse? I doubt it.