I must say I am puzzled by today’s decision of the ECB to leave rates unchanged. It simply does not fit with what Mario Draghi said during the press conference. Let me quote him.
Inflation expectations for the euro area continue to be firmly anchored in line with our aim of maintaining inflation rates below, but close to, 2% over the medium term. At the same time, weak economic activity has extended into the early part of the year and a gradual recovery is projected for the second half of this year, subject to downside risks. Against this overall background our monetary policy stance will remain accommodative for as long as needed.
If words actually mean what they mean, Draghi informed us that (a) inflation, and inflation expectations, are in line with forecasts and objectives; (b) at the same time, economic activity is weaker than expected, and the future recovery is at risk; (c) the ECB is willing to have an accommodative monetary stance.
Two considerations: first, the king is naked; it was obvious from the very beginning that the recovery in the second half of the year was not in the cards. I already discussed the systematic bias in official forecasts. It turns out that simply saying to markets that things will go well, is not sufficient to make them act accordingly. The confidence fairy, as Krugman calls it, is nowhere to be seen. I would add that this systematic bias risks making EMU institutions less credible, and hence further weaken their capacity to anchor private sectors’ expectations…
And then the puzzle: if inflation is under control, and if economic activity is weak, and if the ECB deems accommodation to be needed, why, why on earth are rates kept constant? Should we remind to Mario Draghi what is written in article 127 of the Lisbon Treaty?
The primary objective of the European System of Central Banks, hereinafter referred to as “ESCB”, shall be to maintain price stability. Without prejudice to the objective of price stability, the ESCB shall support the general economic policies in the Union with a view to contributing to the achievement of the objectives of the Union as laid down in Article 3 of the Treaty on European Union.
Among the general policies that the ECB should support there is growth and employment. And lowering the rates today would certainly not lead to “prejudice to the objective of price stability”
Why is the ECB so frightened to send the signal to markets that it is ready to boost economic activity? Is there an hidden agenda we are unaware of?
Il Sole 24 Ore just published an editorial I wrote with Jean-Luc Gaffard, on the structural problems facing the EU. Here is an English (slightly longer and different) version of the piece:
It is hard not to rejoice at the ECB announcement that it would buy, if necessary, an unlimited amount of government bonds. The Outright Monetary Transactions (OMT) program is meant to protect from speculation countries that would otherwise have no choice but to abandon the euro zone, causing the implosion of the single currency. As had to be expected, the mere announcement that the ECB was willing to act (at least partially) as a lender of last resort calmed speculation and spreads came down to more reasonable levels.
I have read an interesting article by Wolfgang Münchau, on the Financial Times. To summarize, Münchau argues that because of politician’s complacency, there is a chance that the new OMTs program launched by the ECB will never be used, and hence prove ineffective in boosting the economy. He therefore argues that the ECB should have done like the Fed, and announce an unconditional bond purchase program (private and public alike).
The piece is interesting because Münchau is at the same time right, and off the target. It is worth trying to clarify.
What to do of yesterday’s decision of the ECB? The tree looks
very rather nice, the forest much less. First, a look at what Mario Draghi announced:
- “[...] the Governing Council today decided on the modalities for undertaking Outright Monetary Transactions (OMTs) in secondary markets for sovereign bonds in the euro area. [...] We aim to preserve the singleness of our monetary policy and to ensure the proper transmission of our policy stance to the real economy throughout the area. OMTs will enable us to address severe distortions in government bond markets which originate from, in particular, unfounded fears on the part of investors of the reversibility of the euro. [...] we act strictly within our mandate to maintain price stability over the medium term.” The technical note accompanying the decision explicitly states what markets wanted to know: “No ex ante quantitative limits are set on the size of Outright Monetary Transactions” In other words, bond purchases will be unlimited.The technical note also specifies the conditionality, the fact that the purchases will be on short maturities, and that they will be fully sterilized.
- Let’s go back to Draghi: “we decided to keep the key ECB interest rates unchanged. [...] inflation rates are expected to remain above 2% throughout 2012, to fall below that level again in the course of next year and to remain in line with price stability over the policy-relevant horizon.“
To summarize, the ECB will try to bring down the spreads, acting within its mandate, because speculation is perturbing the transmission mechanism of monetary policy and threatening stability. This can also help explain the decision to keep the rates unchanged: there is no point in using that lever, unless it is sure it works.
Why is the tree rather good? And what makes the forest more worrisome? The tree first.
The April data on Italian unemployment are out, and they look no good. Not at all. The overall rate (10.2%) is at its maximum since the beginning of monthly data series (2004), and youth unemployment is above 35%. The rest of Europe is not doing any better, with more than 17 millions people looking for a job in the eurozone alone.
We already knew. The latest data just add to the bleak picture. We also know (I discussed it) what the consensus diagnosis is: Too many rigidities, excessively high labour costs, both because of wages and of taxes on labour (the so-called tax wedge). Therefore, let’s have lower wages, and all will be well! Unemployment will disappear, growth will resume. Mario Draghi said it rather nicely:
Policies aimed at enhancing competition in product markets and increasing the wage and employment adjustment capacity of firms will foster innovation, promote job creation and boost longer-term growth prospects. Reforms in these areas are particularly important for countries which have suffered significant losses in cost competitiveness and need to stimulate productivity and improve trade performance.
Last week a number of European public figures joined the ranks of those calling for renewed emphasis on growth. The most remarked was Mario Draghi during his audition before the European Parliament; but equally important was the joint statement of Mario Monti and Manuel Barroso. “Growth” seems to be the word of the month, a must in any European leader’s speech.
I will certainly not complain, about this, because both the reduction of unemployment and the sustainability of public finances in the eurozone simply cannot happen in stagnant economies. Nevertheless, once more, there are some reasons for being worried. At a close look, it seems as if the word were an empty box, simple lip service paid to public opinion in order to keep doing business as usual.
The Brussels EU Summit is extremely negative for the decisions that have been taken:
- We are going to converge towards a “German Europe”, based on fiscal austerity and on compression of domestic demand. The stubbornness in rejecting any role for active macroeconomic policies is scary, especially as we are still engulfed into a crisis that could have been substantially worse, were it not for the stimulus packages of 2009. Just ask a question: where would the EU be, if the rules Germany wants, were already in place in 2008?
- The eurozone emerges from the Summit, once again, as the only major economy of the world that does not have a properly functioning central bank. With the support of ECB President Mario Draghi, it was once again made clear that the ECB should and would not act as a lender of last resort.
There will be time to discuss these issues, and to ask where does the EMU go (or does not go) from here.
Here I want to underline the only positive aspect of the meeting: The (self) exclusion of the UK from the process of further integration. This is seen as dangerous by most commentators. I’d argue that it is the only good news that we got from the sleepless night in Bruxelles.
The European leaders could not afford to emerge from negotiations empty-handed, and this forced them to refuse the British vetoes. For the past 38 years the UK has been constantly pushing on the brakes of European integration, obtaining (should I use the term ‘blackmailing’?) compensations and opt-out clauses for every advance that it reluctantly allowed.
The looming Armageddon gave European leaders the strength to finally break free from this grip.
Europe is finally advancing towards increased cooperation. In the wrong direction, for the reasons recalled above, but it is advancing. It is to be hoped that last night we set a precedent, and that in the future the method of enhanced cooperation will become the norm each time that a country blocks the process for selfish reasons.
I made this point in an interview this morning.
I think it is useful to list, and assess, the main arguments advanced against an enhanced role of the ECB as a lender/buyer of last resort. I can think of four of them: credibility, inflation, irrelevance, ineffectiveness.