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 European Macroeconomics & Governance Tags & Topics

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.

View comments
Read article Download PDF More on this topic More by this author

Policy Contribution

pc15_16

Low long-term rates: bond bubble or symptom of secular stagnation?

Yields on European sovereign bonds have reached historically low levels in 2016. This secular decline in long-term sovereign yields is not limited to the euro area. Why are interest rates currently so low? Are low long-term trates justified by fundamental factors or is it an artificial phenomenon?

By: Grégory Claeys Topic: European Macroeconomics & Governance Date: September 26, 2016
Read about event More on this topic

Upcoming Event

Sep
29
08:30

Inclusive growth in the European Union

Why is inclusive growth important and how do the EU’s social problems differ from social problems in other parts of the world?

Speakers: Brando Benifei, Monica Brezzi, Bea Cantillon, Zsolt Darvas, Jana Hainsworth, Stefaan Hermans, Barbara Kauffmann, Dalia Marin, Tim Murphy, Reinhilde Veugelers, Luca Visentini and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read about event More on this topic

Upcoming Event

Oct
4
12:30

Potential impediments to long-term investment

How can we encourage long-term investment in Europe? Many factors hinder long-term investment but are there risks involved in reviewing existing regulation?

Speakers: Sophie Barbier, Grégory Claeys, Miguel Gil Tertre, Edoardo Reviglio and Sandra Rigot Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read about event More on this topic

Upcoming Event

Oct
10
12:00

Financial Times/Bruegel European Forum: Where now for the UK and the EU after the vote for Brexit?

Three months after the results of the UK referendum there is still a lot of uncertainty about the future. The Financial Times and Bruegel bring together a panel to discuss the most crucial questions.

Speakers: Lionel Barber, James Blitz, Maria Demertzis, Sylvie Goulard and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read about event More on this topic

Upcoming Event

Oct
13
08:30

The Euro and the battle of ideas

Why is the Euro in trouble? Are philosophical differences between the founding countries to blame and can those differences be reconciled?

Speakers: Markus K. Brunnermeier, Harold James and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article Download PDF More by this author

Parliamentary Testimony

written-evidence-house-of-lords-12-9House of Lords

The future of financial services in the UK following the Brexit vote

UK House of Lords EU Sub-Committee on Financial Affairs' call for evidence on the future of Financial Services in the UK following the vote to leave the European Union.

By: Dirk Schoenmaker Topic: European Macroeconomics & Governance, House of Lords, Parliamentary Testimonies Date: September 15, 2016
Read article More on this topic More by this author

Blog Post

Nicolas Véron

The City will decline—and we will be the poorer for it

Just as the City owes much of its current awe-inspiring prosperity to European integration, the brutal realities of Brexit will make it shrink, not thrive. All this is bleak news, not just for the City but for the UK's economy.

By: Nicolas Véron Topic: European Macroeconomics & Governance Date: September 14, 2016
Read about event More on this topic

Past Event

Past Event

From crisis management to launching economic growth

What have been the most effective strategies in limiting the impact of the economic crisis in Europe? What challenges lie ahead? Bruegel's 10th anniversary event in Budapest will foster discussion of these important topics.

Topic: European Macroeconomics & Governance Location: Budapest, Hungary Date: September 14, 2016
Read article Download PDF More on this topic

Policy Contribution

cover

What are the prerequisites for a euro-area fiscal capacity?

In this Policy Contribution, Maria Demertzsis and Guntram B. Wolff discuss three progressive steps for strengthening the fiscal framework at the euro-area level. These lead to less interference in national fiscal policymaking thanks to a more credible no-bailout clause, increased risk sharing and different degrees of provision of euro-area-wide public goods and fiscal stabilisation.

By: Maria Demertzis and Guntram B. Wolff Topic: European Macroeconomics & Governance Date: September 9, 2016
Read about event More on this topic

Upcoming Event

Nov
21-22
13:30

Vision Europe Summit 2016

The 2016 Vision Europe Summit is titled "Redesigning European Migration and Refugee Policy" and will be held in Lisbon on 21-22 November 2016.

Topic: European Macroeconomics & Governance Location: Lisbon
Read article More on this topic More by this author

Blog Post

Dijsselbloem photo

Speech by Jeroen Dijsselbloem at Bruegel Annual Dinner 2016

Jeroen Dijsselbloem, President f the Eurogroup, delivered the keynote speech at Bruegel's Annual Dinner 2016, held on 6 September 2016.

By: Jeroen Dijsselbloem Topic: European Macroeconomics & Governance Date: September 7, 2016
Read article More by this author

Podcast

Podcast

The future of Europe

Europe is at a crossroads. What must European leaders do to combat populism, the refugee crisis, and low growth?

By: Bruegel Topic: European Macroeconomics & Governance, Global Economics & Governance Date: September 7, 2016
Load more posts