Tag Archives: ecb

European Central Bank: Further Easing Needed

The European Central Bank announced that it will open to further easing in order to stimulate the economy. Euro weakens after central bank officials discussed possibility of asset purchases. At the same time, the rest of the world, for example the U.S. and China, are winding down their growth rate. According to Wall Street Journal, President Mario Draghi‘s revelation that the central bank had discussed negative interest rates and large-scale bond purchases — if needed to keep persistently low inflation from undermining growth — caught financial markets by surprise.

[Mr. Draghi said officials had discussed asset purchases, known as quantitative easing, as well as setting a negative rate on bank deposits parked at the ECB—moves that could help bolster the economic recovery and push up prices. The annual inflation rate in the euro zone is just 0.5%, far below the bank’s target of just under 2%.]

At the beginning of this semester, we learnt that the negative interest rates will encourage people to spend more which leads to an increase in aggregate demand; however, this may discourage you from saving your money – the more you save the more you would lose. Theoretically, people have less incentive to save and therefore banks have no reserves for lending loans.

A negative interest rate (though it is currently zero) would also force financial institutions to pay to park their excess funds at the ECB, leading them to lend more to the private sectors. However, in my opinion, quantitative easing is more complicated in the euro zone than in the U.S., where the Federal Reserve has deployed the policy and continues to do so. This is because on the one hand, like states in the US, countries in Eurozone have no exchange-rate tool, no separate monetary policies; however, on the other hand, unlike US states, labor is less mobile across countries and wages are less flexible due to social policies, and there is no mechanism for fiscal transfers among countries. The U.S. borrows more from the capital markets and therefore could filter quickly to its economy.

The good news is that euro zone has a low inflation rate. The long-term interest rates therefore remain quite fixed which provides a relatively stable environment for households and business to spend and invest. However, if the interest rates are too low, countries may face some risks, for example, Japan has struggled with deflation for two decades. In order to control the risk, both ECB and Fed aim to keep inflation rate at around 2%.




What the ECB could learn from Denmark

The United States has managed to navigate around the “zero lower bound problem” by utilizing quantitative easing.  The European Union has not been so fortunate.  Due to the little to no inflation (.7%), many doubt the recovery and this uncertainty is causing money market interest rates to increase.  This increase in cost of borrowing could put the brakes on recovery for Europe and lead to deflation.  Promise of decisive action may not be enough anymore.   The European Central Bank in the past has admitted that it is ready to take whatever action is necessary.  The ECB has many tools at its disposal, including quantitative easing.  Yet there is a call for rate cuts that could violate the zero lower bound.  This would be the first attempt in Europe since Denmark implemented one in 2012.

To understand what the central bank would be attempting, it is necessary to distinguish between two rates that they could change,  the refi rate and the deposit rate.  The refi rate is the European analogue to the federal funds rate, and it currently stands at .25.  The deposit rate is the rate that the ECB pays on deposits banks make with the ECB, and it is already at 0%.  Even though a decrease in the refi rate is more likely, I believe that a negative deposit rate could help Europe far more then cutting 15 basis points from the refi rate or quantitative easing.

The negative interest rates in Denmark are largely viewed as a good thing.  Denmark’s use of a negative interest rate was motivated by monetary policy trying to keep a stable exchange rate with the Euro.  Due to differences in scope and motivation, a few questions need to be addressed when considering such a policy.

One problem is that it has the feeling of a tax on bank’s cash.   This shouldn’t be much of a concern since measures such as negative interest rates are not permanent.  Few people would think it unfair to trade European recovery for a year or so of decreased profits for banks.  Another problem is decreased liquidity.  This is an unavoidable side effect of a policy that penalizes cash.  However there is evidence that liquidity could be increased easily if need be, suspending the so- called “sterilization”.  What is without question is that it will get cash off the sidelines and pumping through the economy.

The economic turmoil in Europe continues.  High unemployment and almost nonexistent inflation threaten the economies of Eurozone. Negative interests rates could play a role in jump-starting the continent.  In the past Europe has been hesitant to apply QE due to concerns about how to unwind such a program, as well as questions about its effectiveness.  By utilizing negative interest rates, the ECB avoids building a massive balance sheet to unwind while sending a strong message that the ECB will do what it takes to get Europe growing again.

Central Banks Around the World

On the 28th of January, the Federal Operations Market Committee announced that they will taper additional $10 billion from its original quantitative easing program. The general concession is that as a response to FOMC central banks around the world will also adjust their strategies. Here are some expectations and outlooks according to Bloomberg news.

Bank of England

The Bank of England’s nine-member monetary policy committee will leave its key rate at a record-low 0.5 percent and its bond-purchase program target at 375 billion pounds ($617 billion), according to Bloomberg surveys before the decision on Feb. 6.

European Central Bank

The European Central Bank on Feb. 6 will keep its benchmark interest rate unchanged at a record-low 0.25 percent, according to the median forecast in a Bloomberg survey.

Australian Central Bank

Australia’s central bank will probably keep its benchmark interest rate at a record-low 2.5 percent at its first policy meeting for the year on Feb. 4, according to all 34 economists surveyed by Bloomberg. Economists will be focusing on the Reserve Bank of Australia’s comments on the currency and indications it may have dropped an easing bias.

Brazilian Inflation

A report from Brazil’s statistics agency on Feb. 7 may show inflation moderated to 5.66 percent in the first month of 2014. That would be the slowest since November 2012 after policy makers raised benchmark interest rates for seven straight meetings to ease consumer-price increases that still exceed the 4.5 percent target.

Although these are merely expectations and not set in stone, there are some patterns. Many central banks will maintain if not further lower interest rates in order to keep liquidity relatively high in the market. However, other countries have decided to raise their interest rate in control the inflation rates. It may be an overstatement to say that this was all caused by the Fed’s announcement, but with the recent emerging market being hit–at least temporarily, as I have discussed in my previous post–these measures seem pretty natural.

Eurozone, after disregarding many intertwined stories it had in the past few years, is experiencing very low level of inflation. Last year, it had an annual inflation rate was 0.7%, which is fourth consecutive years with inflation rate below 1% mark. Although economists’ consensus is that it is doubtful Euro will experience outright deflation, but ECB will need to ease monetary policy to control inflation at its target just below 2%.

As for Bank of England, it is quite clear that they are not going to tighten their monetary policy since the threshold for unemployment rate (7%)  is still not met. And the Reserve Bank of Australia is under pressure after its currency tumbled after emerging market down-trough. For these two countries, they do not have too much reasons to diverge from original planning to set lower interest rate.

Brazil is a little bit different. Brazil has experienced inflation level that is way above its target rate. Many of it is not due to monetary policy, but Brazil has missed its fiscal target by the most in 2013 with largest deficit since 2002. Ever since Brazil’s effort to slow down their inflation rate since November 2012, this is the slowest it has been at 5.66.

Most of these countries meeting will be held in mid-February. FOMC had its move and now it will be other countries to adjust accordingly. After all, US’s economy is still biggest in the world. With tapering in place, the money supply is shrinking gradually. Foreign exchange rates having been affected shortly after the FOMC announcements and foreign investments shrinking, I would like to see how much of these expectations will be met.

Running out of air? The Eurozone at the edge of deflation

Two days ago, I saw something that actually resembled good news from Europe. Naturally, I immediately became suspicious; things couldn’t really be going well for once, could they? And, sure enough, it seem they aren’t. The Eurozone is possibly facing deflation now (the German Bundesbank disputes this, of course, but then my wonderful home country doesn’t have the best track record for facing the facts and accepting economic reality when it comes to the crisis anyway). The Economist even has a four part round table on the topic. I think it’s safe to say that this could become a serious problem (which is great, because Europe doesn’t have enough of those already).

What I find most alarming about this isn’t so much that the danger exists as such. The absolute lack of expansionary fiscal policy – worse yet, the harsh austerity imposed throughout the Eurozone – left the ECB hanging in the air. Sure, Mario Draghi did what he could to stimulate the Euro-area economy (which, by the way, a lot of people don’t realize; the ECB gets criticized as much as state governments for failing to solve the crisis, when I’d argue that they were pretty much the only ones doing anything at all). But, as I probably don’t need to elaborate writing for a bunch of econ majors, when facing the ZLB, monetary policy tends to lose its bite. So a slow recovery and low inflation rates (or even deflation) were always going to be a possible issue for the Eurozone.

What’s alarming is that nothing’s being done about it. The ECB has such a weak mandate that even now, with deflation looming large on the horizon, QE still isn’t an option because certain member states – take a wild guess at who’s most vocal about it – are strictly opposed to that policy. Ironically, the head economist of Germany’s largest bank, the Deutsche Bank, has expressed support for QE. Too bad he’s head economist of the wrong bank. Hell, even the OECD is on board!

What’s also striking about this is that the ECB – much like the Fed – is aiming for an inflation target of 2% across the Eurozone, which it is currently missing by a mile (you may think it’s redundant to say that the Eurozone faces a deflation risk and that their inflation is low, and in fact you might assume most sensible people should feel that way; however, given that the Bundesbank’s economists see these same numbers and still manage to declare that there’s nothing to worry about makes me question that assumption). So even if deflation wasn’t an issue, the ECB should do what it takes to get the inflation rate back on track. The fact that its hands are bound to do the one thing (that’s right, it doesn’t even have to take responsibility for the outrageous levels of unemployment seen in many European states, because that’s not part of its mandate) it’s supposed to be doing is simply ridiculous.

My point here isn’t so much that the ECB must, must, must implement QE. In fact, I don’t care what strategy they can come up with that prevents deflation and is acceptable to its governing council (and while they’re at it, I think reducing unemployment wouldn’t hurt, even if it’s not part of their prime directive). Although QE does stick out as the most obvious choice.

My point is that simply doing nothing is absolutely unacceptable. That’s true even if you don’t believe that deflation is a real threat ; the ECB still has an inflation target, and it’s still missing that target. Beyond that, my point is that certain Eurozone countries – most prominently Germany – should start to get real about the EU and what it means to them. But that’s something I’ll talk about in my MLK Day post.