The new ECB measures

by on June 5, 2014 at 9:31 am in Current Affairs, Economics, Political Science | Permalink

My perhaps overly simplistic view is that unless some of the various electorates hate the announced measures, they are not enough.  An adequate response would be “we are going to raise the rate of price inflation, probably indefinitely, and furthermore countries x, y, and z have agreed they are not getting all of their money back.  They agree to pick up the check and their electorates hate this but accept it as well and furthermore all the politicians involved are telling their electorates the same thing that they say amongst themselves.  We also accept that weak lending to medium- and small-sized business represents a real competitiveness problem, a kind of Great Reset, and is not amenable to a simple monetary policy fix but we have to do something so we will try anyway.”

Obviously Draghi was in no position to make such an announcement.  I once liked the idea of a negative rate on deposits at the central bank, but I no longer do.  I think it will represent more of a tax on future lending than a spur to current lending.  Denmark once tried such a policy and it didn’t do much for them.  It is probably a one-off shot in the new “currency wars” but not a game-changer.  In any case total bank deposits held at the ECB are relatively small.

We’ll see what else Draghi announces later today.  European stocks are up, so it is hard to argue with this as an improvement over the status quo ex ante, which of course was terrible.  Still, I am not as impressed as are many of the people in my Twitter feed.

1 ptuomov June 5, 2014 at 9:55 am

First, on the market reaction. This action has been leaked/signaled to the markets in many ways over the last month. Therefore, to judge the market reaction to the ECB action, I think one should look at the change from early May to today.

Second, what’s the difference between non-sterilized SMP and QE? Not much, maybe maturity. I think this was the more significant development moving the market over the past month than negative deposit rates.

2 Ray Lopez June 5, 2014 at 9:55 am

What happened? This op-ed by TC is a prophylactic chess move that’s many moves deep, but it’s so deep that I’m not clear what precipitated it. Some sort of announcement by the ECB? “ECB effectively charging banks to hold reserves
USA TODAY-49 minutes ago The European Central Bank moved aggressively Thursday to boost a tepid economic recovery and ward off the threat of deflation by cutting its ..” — oh, this seems like old news, old boring news.

3 prior_approval June 5, 2014 at 11:23 am

Eurogeddon delayed? Eurogeddon assured?

A higher dollar leading to likely higher trade deficitst from the eurozone – priceless.

And even Prof. Cowen seems a bit aware of what is going on – ‘It is probably a one-off shot in the new “currency wars” but not a game-changer.’

Anyone remember when currency devaluation was the preferred solution for problems in Greece, Spain, et al?

The EZB hasn’t.

4 ThomasH June 5, 2014 at 5:57 pm

It is still the preferred solution, but not possible within the Euro framework. What ECB is aiming at is devaluation of the Euro, or ideally competitive devaluations that will leave European inflation higher. Direct purchase of USD assets would seem simpler.

5 Commentateur June 6, 2014 at 2:52 pm

“Direct purchase of USD assets would seem simpler.”
US or UK economists won’t get this until too late; the Euro was created as a way to get away from the dollar.

Devaluation is NOT the preferred solution in the EZ. It is the preferred in the dollar bloc Fed/BoE/BoJ (and IMF) and this, ultimately, is preventing them restructuring, and will destroy their currencies.

The whole point of the ECB is to have a Central Bank free of national govt influence which allows it to keep its currency purchasing power stable. They take their mandate very seriously.
Draghi has to pretend to be playing the dollar bloc game and fear very low inflation.

He understands that inflation ≠ growth.

These graphs show that ECB going in a totally different direction to the Fed, a direction that dollar bloc denizens seems unable to imagine.

6 Jan June 5, 2014 at 11:29 am

Seems like this would have been good to try a couple years ago. Is it bad in part because it is just too late?

7 Bill June 5, 2014 at 11:30 am

Austerity was supposed to pull them out of this.

Take more medicine.

Even if it makes you sick.

8 T. Shaw June 5, 2014 at 1:20 pm

Simply, this is the latest monetary policy boondoggle in the annals of central bank incompetence.

9 mulp June 5, 2014 at 2:51 pm

How does creating incentives to invest in real capital assets cause inflation?

Obviously, banks lending to build real capital assets will want assurances that the asset buyer or the asset itself will service the debt, but with cash losing value in the bank, the interest rate on the debt is lower which reduces the return on capital rate needed to meet the prudence hurdle.

Given the EU is at serious energy shortage risk, this should spur construction or wind and solar, switching from fossil fuel heating/cooling to ground source HVAC, or simply replacing old lamps with LED. A $20 LED replacing a $2 bulb does not result in “savings” for perhaps five to ten years, but if the $20 bill in the bank shrinks to $18 in five years while the electric rate costs $10 more than the LED’s electricity would, not investing the cash became a marginally worse investment.

And given people drive 5 miles out of the way to save 2 cents a gallon on gas, the ECB policy is a signal that spurs irrational response just like the slightly cheaper gasoline.

But this won’t cause inflation in today’s economy. The manufacturers of LEDs are going to easily hire more workers to operate the factory at even higher utilization or build new factories that are now cheaper because of economies of scale using workers who are newly hired and thus getting lower wages to help the experienced workers who get the high pay.

The inflation caused by easy money has been concentrated in asset price inflation, but primarily in the assets where killing jobs justifies the asset price inflation. The result of the money flooding into the security markets has been to drive job killing cuts in costs to boost profits to justify the higher prices.

The skyrocketing stock prices from cash flowing into the investment funds of IRAs and 401Ks and profit slush fund is not going to hire workers because workers are paid too little to buy more, so costs need to be cut without hiking prices, and in many cases, cutting production and cutting workers is more profitable – the workers cut don’t cut demand as much as it increases profits by cutting costs. Its the classic restrict supply to increase profits that is taught in elementary econ.

Only when a firm is looking at cash that is going down in value and thus hurting profits will it decide to hire workers to make something new or to do more marketing or something with the cash. Its better to explain “we invested $10 million in a new product design” instead of “we sat on $10 million in cash and it shank to $9.9 from negative interest.”

10 Tom June 6, 2014 at 1:16 am

There’s two ways to read this: as a weak effort to devalue the euro, or as a misguided attempt to increase inflation.

Nobody seems to think it will work as devaluation. Compare to how markets reacted to Japanese QE. The euro has weakened a bit over the past month, perhaps in anticipation, but it hasn’t broken out of the range it’s been trading in for more than six months.

It’s hard to fathom how anybody still believes the old monetarist shtick that base money supply drives inflation. Even Japan hasn’t created any demand-pull inflation, only cost-push energy import inflation. If you want to boost inflation, you’ve got to boost spending. Personally I think it would be dangerous for Europe to try leveraging up its public sector, however calm sovereign debt markets might seem now.

11 Commentateur June 6, 2014 at 3:00 pm

You have suggested two ways to read this, both are wrong.

Draghi does not want inflation, but the moronic markets and dollar bloc countries + IMF mean it’ s in the EZ’s short term intreats to pretend he does.

The Eurozone is designed to be a low/no inflation currency. They raised the target to 2% around 2003 to deal with jump in inflation (exported mostly from the US).

Low inflation means higher real demand. Or as Draghi said himself: “With low inflation, you can buy more stuff,”

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