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 Topic: European Macroeconomics & Governance

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.


Warning: Invalid argument supplied for foreach() in /home/bruegelo/public_html/wp-content/themes/bruegel/content.php on line 449
View comments
Read article More on this topic More by this author

Blog Post

Revision of the Posted Workers Directive misses the point

The Commission’s proposed revision of the Posted Workers Directive has been approved by the European Parliament’s Employment Committee, which welcomes the arrival of “equal pay for equal work”. But the revision will have little impact, and was largely unnecessary. Instead we should focus on the fight against bogus self-employment, social security fraud and undeclared work.

By: Zsolt Darvas Topic: European Macroeconomics & Governance Date: October 18, 2017
Read article Download PDF More on this topic

Policy Contribution

Spotting excessive regional house price growth and what to do about it

Rapidly rising house prices are a well-known source of financial instability. This Policy Contribution examines whether there are regional differences in house price growth within European countries and, if so, whether this warrants more targeted measures to address vulnerabilities.

By: Grégory Claeys, Konstantinos Efstathiou and Dirk Schoenmaker Topic: European Macroeconomics & Governance Date: October 18, 2017
Read about event More on this topic

Upcoming Event

Oct
26
14:30

Growth, productivity and social progress in Europe

On 26 October, Bruegel is organizing an interactive brainstorming seminar on Growth, Productivity and Social Progress in Europe. This is a closed-door, high-level workshop for a selected number of experts in the field.

Speakers: André Sapir Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read about event More on this topic

Upcoming Event

Nov
6
12:30

An independent assessment of the EU's fiscal framework: presentation of the first annual report of the European Fiscal Board

This event will feature a presentation of the first Annual Report of the European Fiscal Board.

Speakers: Mateusz Szczurek, Niels Thygesen and Further speakers to be confirmed Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article

Blog Post

An update: sovereign bond holdings in the euro area – the impact of quantitative easing

Since the European Central Bank’s announcement in January 2015 of its quantitative easing programme, national central banks have been buying government and national agency bonds. In this post we look at the effect of QE on sectoral holdings of government bonds, updating calculations that we published initially in May 2016.

By: Pia Hüttl and David Pichler Topic: European Macroeconomics & Governance Date: October 10, 2017
Read article

Blog Post

India’s trade ties with the UK and EU

As EU and Indian leaders meet in Delhi, we look at the figures on trade. The UK’s place in the relationship warrants special attention. EU-India trade has more than tripled since 2000, but UK-India trade is largely static. The shift is especially noticeable for EU exports to India, where the UK share has dropped from 29% to 10%.

By: Maria Demertzis and Alexander Roth Topic: European Macroeconomics & Governance, Global Economics & Governance Date: October 6, 2017
Read article More on this topic More by this author

Blog Post

Catalonia and the Spanish banking system

As tensions rise around Catalonia's independence movement, there are worries about the impact on the Spanish banking sector. Banks based in Catalonia account for around 14% of total assets. Some major institutions are already moving their headquarters to other parts of Spain. However, most Spanish banks have significant exposure to the Catalan market, and all could be caught up in the turmoil.

By: Yana Myachenkova Topic: European Macroeconomics & Governance Date: October 6, 2017
Read article More on this topic

Blog Post

What has driven the votes for Germany’s right-wing Alternative für Deutschland?

The AfD vote in East Germany was consistently stronger than in the West, even after controlling for income, age, education, religion and the overall rural nature of the new Bundesländer.

By: Alexander Roth and Guntram B. Wolff Topic: European Macroeconomics & Governance Date: October 5, 2017
Read about event

Upcoming Event

Nov
28
12:30

Sustainable growth in transition countries

This event will feature a presentation of the EBRD Transition Report 2017-18.

Speakers: Jonathan Charles, Zsolt Darvas, Jean Pisani-Ferry, Sergei Guriev and Debora Revoltella Topic: European Macroeconomics & Governance, Finance & Financial Regulation Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article Download PDF

External Publication

European Parliament

The single monetary policy and its decentralised implementation: An assessment

This paper assesses the decentralised implementation of monetary policy by the Eurosystem in terms of its transparency, efficiency and simplicity. Compared to the Fed, the Eurosystem seems to have higher staff numbers and operational costs for similar tasks.

By: Francesco Papadia and Alexander Roth Topic: European Macroeconomics & Governance, European Parliament, Testimonies Date: October 4, 2017
Read article More on this topic More by this author

Blog Post

Ukraine’s oligarchs are bad for democracy and economic reform

Ukraine’s late and incomplete economic reform created a class of super-wealthy oligarchs who now stand in the way of further liberalisation. The oligarchs’ oversized influence only deepens public distrust in a structurally weak political system. Nevertheless, Ukraine is making some attempts to uproot corruption and the next steps are clear.

By: Marek Dabrowski Topic: European Macroeconomics & Governance Date: October 3, 2017
Read article Download PDF More by this author

External Publication

An innovation deficit behind Europe’s overall productivity slowdown?

Reinhilde Veugelers' chapter in "Investment and Growth in Advanced Economies", conference volume of the European Central Bank’s Forum on central banking in Sintra.

By: Reinhilde Veugelers Topic: European Macroeconomics & Governance, Innovation & Competition Policy Date: October 2, 2017
Load more posts