In a context where the ECB puts in practice a full expansionary monetary policy, such as the current scenario, making use of all conventional instruments that a Central Bank has to expand money supply and create the conditions to maintain credible its own price stability mandate, the inefficacy of this policy has been clear. The CPI in the Eurozone, since the halt of the SMP program in February of 2012, has been declining, having reached a minimum value of 0,3% in this current month:
In fact, the expansionary stance summarized in the figure below has failed to swell the ECB balance sheet, Commercial Banks failing to absorb the available liquidity put available by the Central Bank.
IMF Staff Statement
As a matter of fact, even though the ECB has been lowering the interest rates to its bare minimums, Commercial Banks have been lowering the amount available for borrowing by both households and firms as shown in the picture below. This behaviour evidenced by commercial banks is a way to address two issues at the same time: their past and their future. Regarding the past, commercial bank’s balance sheets were abundant in sovereign debt bonds, which were considered to be safe investments with very low risk. However, the 2011 sovereign debt crisis brought about a decrease in the value of such bonds, constraining available borrowing amounts. On the other hand, the dark future ahead leads to a decrease in the willingness to lend. Hence, the credit channel, the transmission mechanism for monetary policy, ceases to function properly.
Banks Balance Sheet, http://www.euro-area-statistics.org
Facing an inefficient monetary policy where conventional policy instruments do not work the ECB turns itself for unconventional measures, quantitative easing.
Quantitative easing is a so-called unconventional tool, allowing the ECB to inject liquidity into the real economy circumventing the Banking system. Through purchases of assets, either private or public (or both), in the secondary market, the ECB can substitute Commercial Banks, partly, in their role of lenders in the European economy. Apart from the direct substitution of Commercial Banks by the ECB, QE will also mean a direct injection of capital from the Central Bank to Commercial Banks, creating excess reserves which together with low interest rates amplify the incentive for an increase in Domestic Credit. The borrowing criteria from Commercial Banks when confronted with excess reserves can smooth, a greater amount of credit being conceded by Commercial Banks.
From early September of 2014 a first-stage QE characterized by purchases of Asset-Backed Securities (private assets) was initiated by the ECB, having as motivation cutting with the continuous decrease in CPI.
The main problem in the Euro Area when considering QE are Financial Markets, the targets of QE. Less developed than those of the US, the most developed market in Europe is the sovereign debt market.
So, to impose a credible QE program the ECB is limited by the private financial European markets. The ABS program while focusing on securitized markets is insufficient to expand significantly the ECB balance sheet.
To implement a credible dimensioned QE that allows a rapid and significant expansion of the ECB balance sheet, creating clear effects in Money Supply, the ECB has as its main platform the Sovereign Debt market.
The implications of a QE conducted by the ECB Governing Council characterized by purchases of Sovereign debt from the 18 member-states is, nowadays, having into account the macroeconomic context of the European economy, and the context of the European Area, highly debatable.
A Sovereign debt purchase program from the ECB brings two main problems:
1. Moral Hazard: Highly indebted peripheral economies with high deficits and current fiscal adjustments in practice have incentives to deviate from such adjustments as the Sovereign debt previously at hands of Commercial Banks passes into the ECB Balance Sheet.
2. Purchase Allocation: 18 Member-states sovereign debt that have to be bought by the ECB, the shares being directly linked to the respective sizes of such economies, each member-state having different necessities. Peripheral economies lacking credit, these representing only part of the Euro Area, Central and North economies with fiscal surpluses and sufficient credit, both being target of QE by the ECB.
A QE program focused in the Sovereign Debt should incorporate in its construction solutions for such difficulties, still, for this the ECB would have to enter in unlegislated ground, expanding its own mandate of achieving price stability through the coordination of the European monetary policy. To cut with the ill incentives that such purchases create for the adjusting peripheral economies and to compensate for injecting capital in “surplus” member-states with less need of credit, the ECB would have to impose certain conditions related with the Fiscal spending for such economies. The ECB would then impose indirectly a fiscal policy orientation for such economies, a clear unofficial expansion of the ECB powers which coordinates monetary policy in an European Union characterized by Sovereign Fiscal policies.
This leads us to a broader discussion. The current standpoint increases the importance of unconventional ECB policies which impacts must be carefully analysed. Such measures end up putting stress on the European Project as a whole, since the limbo between sovereignties and supra-national decisions can choke useful policies and reforms.
Filipe Figueiroa #765, Jaime Marques Pereira #716
– Euro Area Policies, Staff Report, IMF Country Report No. 14/198 (July 2014)
– Feldstein, M., Dos and Don’ts for the European Central Bank, Project Syndicate (July 2012)