Blog Post

The ECB should be more aggressive on monetary policy

The ECB’s promise to do “whatever it takes” has stabilized the euro but its hesitant stance to fight low inflation or even deflation will undermine stability. The case for more aggressive action is strong. 

By: Date: March 3, 2014

The case for more aggressive action is strong. Inflation in the euro area has been steadily falling since the end of 2011 and now stands at 0.7%, well below the European Central Bank’s target of below but close to two percent. The consensus inflation forecast estimates a 1.1% rate for 2014, while market-based indicators suggest that inflation will remain below 1.4% at a five year horizon. Clearly, the euro area has been experiencing major disinflationary tendencies. The ECB’s bank stress tests and asset quality review could lead banks to further curb lending and also global risk and a euro appreciation could undermine the recovery. In combination, deflationary risks are significant while the risk of overshooting the target is minimal. Yet, debt sustainability in many European countries will look illusionary with low and falling inflation rates. Unsustainable debt would then certainly trigger the next crisis. So what could be done?

The starting point should be more aggressive standard monetary policy. The ECB was slow to cut its main rate last year. The public debate in Germany – that low rates reduce the return on German savings – should not influence the ECB’s decision-making. Monetary policy by its very nature has distributional consequences. The ECB’s legitimacy depends solely on fulfilling its mandate, which requires it to contribute to the goals of the European Union, including increased economic and social cohesion, when its price stability mandate is fulfilled. The current disinflation certainly undermines cohesion as it undermines the sustainability of periphery debt. A further reduction in the rate combined with another long-term refinancing operation would be natural and fully within the mandate.

Second, the ECB should take measures to improve directly the credit flow to corporations and households, which is still impaired in the euro-area periphery. Certainly, part of the financial fragmentation is a consequence of the unfinished business of bank balance sheet repair and should be addressed in the asset quality review, the stress test and the subsequent bank restructuring. However, monetary policy should be used to increase the credit flow and avert the risk of deflation. The experience of the last Long-term refinancing operations round (LTRO) was mixed because a lot of the additional liquidity went into the purchase of government bonds instead of credit to firms. The ECB should therefore clearly communicate that it will penalise government bonds in the asset quality review, thereby pushing lending to the real economy. A lowering of collateral standards for credit to firms would be a further instrument.

Third and most controversial would be asset purchases. The purchase of corporate bonds and loan portfolios sold by banks would be relatively uncontroversial and would improve credit conditions in the euro-area periphery. Ending the sterilization of past government bond purchases would also be uncontroversial and push liquidity into the market. More controversial would be the buying of a portfolio of government bonds. It should reduce the spreads between the euro-area periphery and the core but its overall effectiveness is questionable and it will not increase growth and inflation in the core of the euro area by much. Funding conditions for corporations in Germany and France are already very favourable and German corporations in particular rely on abundant internal finance for their investments. For the periphery, however, the Outright Monetary Transactions (OMT) programme appears more appropriate as a last recourse measure, which requires a debt-solvency assessment and conditionality.

Overall, more monetary action is clearly advisable and would not require the ECB to go beyond its mandate. In particular, the euro-area periphery would benefit from another LTRO and credit-easing measures. The euro-area core, in particular Germany, needs supply-side reforms, measures to reduce the tax burden on the middle class and increased public investment in order to re-invigorate growth and increase inflation. Monetary policy needs to do more but further government action is also needed.

 


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

Topics

Comments

Read article More on this topic

Blog Post

Pia Hüttl
jaume

Northern Ireland and EU funds

EU funding for the UK has risen considerably since 2000, but funding predominantly goes to rural and less developed areas, meaning that Northern Ireland, Scotland and Wales receive more funding relative to their GDP than England.

By: Pia Hüttl and Jaume Martí Romero Topic: European Macroeconomics & Governance Date: May 3, 2016
Read about event More on this topic

Past Event

Past Event

Fighting corruption: from headlines to real impact

Despite recent efforts to tackle corruption there is not much evidence that these strategies are producing results. Why is this the case and what can we do to improve the situation?

Speakers: Carl Dolan, Mihaly Fazekas, Alina Mungiu-Pippidi and Alessio Terzi Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: April 28, 2016
Read about event More on this topic

Past Event

Past Event

Active labour market policies, what works?

How are Europe's labour markets performing, and what policies can best help them function?

Speakers: Alfonso Arpaia, Clyde Caruana, Grégory Claeys, Dan Finn, Regina Konle-Seidl, Alfred Mifsud, Godwin Mifsud, Edward Scicluna and Paul Swaim Topic: European Macroeconomics & Governance Location: Mediterranean Conference Centre Triq l-Isptar, Valletta, Malta Date: April 27, 2016
Read article More on this topic More by this author

Blog Post

Jérémie Cohen-Setton

Understanding HM Treasury’s Brexit analysis

What’s at stake: The UK will hold a referendum on its membership of the EU on June 23rd 2016. Her Majesty’s Treasury released an assessment of the impact of Brexit finding that the economy would be between 3 and 7% smaller in 2030 if the UK left the EU than it would be if it stayed in.

By: Jérémie Cohen-Setton Topic: European Macroeconomics & Governance Date: April 25, 2016
Read about event More on this topic

Upcoming Event

25 
May
2016
12:30

Lessons for the euro from early US monetary and financial history

The United States has a monetary union that many look to when considering the future of the EU. But how easy was it really to create such a union and what can Europe learn from the US process?

Speakers: Jeffry Frieden and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article More on this topic More by this author

Blog Post

jaume

Are regional governments causing deficit overshooting in Spain?

Spain once again missed its deficit target in 2015 and it seems unlikely that 2016 will be any better. The central government has pointed to regional deficits as being the cause of the fiscal slippage. However, regional governments claim that their deficit is due to under-financing and overly strict deficit targets.

By: Jaume Martí Romero Topic: European Macroeconomics & Governance Date: April 19, 2016
Read about event More on this topic

Past Event

Past Event

CANCELLED: The Search for Europe

This event has been cancelled because of an unforeseen change in the calendar of the main speaker.

Speakers: Francisco González, Sylvie Goulard, Veronica Nilsson, John Peet, Javier Solana and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: April 19, 2016
Read article More on this topic

Blog Post

IMG_20151009_103117 (3)
Karen E. Wilson
Guntram B. Wolff

Youth unemployment in the Mediterranean region and its long-term implications

Youth unemployment in the Mediterranean region has consequences for the whole of Europe. Tackling youth unemployment in the region must continue to be a high policy priority.

By: Nuria Boot, Karen E. Wilson and Guntram B. Wolff Topic: European Macroeconomics & Governance Date: April 13, 2016
Read article More on this topic

Opinion

Grégory Claeys
Zsolt Darvas

How to reform EU fiscal rules

The current inefficient European fiscal framework should be replaced with a system based on rules that are more conducive to the two objectives of public debt sustainability and fiscal stabilisation.

By: Grégory Claeys and Zsolt Darvas Topic: European Macroeconomics & Governance Date: April 12, 2016
Read article More on this topic More by this author

Opinion

Guntram B. Wolff

Making the EU-Turkey refugee deal work

The EU deal with Turkey reached on 18 March is problematic, but without a deal the EU’s external borders would have collapsed completely. Now the EU needs to support Greece and increase the number of refugees taken directly from Turkey.

By: Guntram B. Wolff Topic: European Macroeconomics & Governance Date: April 11, 2016
Read article More on this topic

Opinion

fratzscher-03
Reint_Gropp_m
p2-Kotz
jan-pieter-krahnen
odendahl-june14-1409577172
Beatrice Weder di Mauro
Guntram B. Wolff

Mere criticism of the ECB is no solution

What would happen if the ECB failed to respond to the excessively low inflation and the weak economy? And what economic policy would be suitable under the current circumstances, if not monetary policy?

By: Marcel Fratzscher, Reint Gropp, Hans-Helmut Kotz, Jan Krahnen, Christian Odendahl, Beatrice Weder di Mauro and Guntram B. Wolff Topic: European Macroeconomics & Governance Date: April 10, 2016
Read article More on this topic More by this author

Blog Post

Zsolt Darvas

The structural budget balance limbo

A key indicator in the EU’s fiscal framework is the structural budget balance, but estimates of the indicator by the European Commission, IMF and OECD are revised a lot from one year to the next, sparking concerns among some EU finance ministers.

By: Zsolt Darvas Topic: European Macroeconomics & Governance Date: April 7, 2016
Load more posts