March 30, 2014 4:59 pm
Europe’s central bankers talk too much and act too little
By Wolfgang Münchau
It’s showtime and quantitative easing is the only big policy tool left to do the heavy lifting
It is five months since the sharp and persistent drop in eurozone inflation, and the gnomes in the European Central Bank’s governing council are talking and talking and talking.
They say things such as: there are no technical or legal obstacles to negative interest rates or quantitative easing. But they do not act. Sometimes there is a mercifully quiet day when only one of them opens their mouth. But last week we had five speeches or interviews on a single day. They sounded dovish. Or did they?
Some outside observers expressed confidence that QE – the “creation” of money through asset purchases that increase the size of the central bank’s balance sheet – was now more likely because Jens Weidmann, president of the Bundesbank, apparently moderated his language.
So why, one wonders, do the central bankers not simply shut up and act instead? My guess is that they will go for QE, but not now. I have heard the view that the ECB plans to wait until after the European parliamentary elections in May. I hope this is not the case. Allowing inflationary expectations to drop below target for political reasons would destroy the ECB’s credibility beyond repair. So they talk because they do not want to act. Talk is free. I know that some of them believe in the magic of verbal intervention – the central bankers’ equivalent of a free lunch. Tell the markets that your exchange rate is overvalued – and it magically adjusts. Just say the word.
On one occasion the trick worked. In the summer of 2012 Mr Draghi said he would do “whatever it takes” to save the euro. He constructed a programme around this promise: Outright Monetary Transactions. It cost nothing. Investors were assured that the ECB would never allow a eurozone country with reasonable policies to default. The interest rates on sovereign bonds have since dropped and stayed low.
It would be a mistake to extrapolate from this experience. OMT was not classic monetary policy. The judges on Germany’s constitutional court argued that it is not an act of monetary policy at all but a political intervention – a ruling I believe to be justified. OMT worked because it was political. Its credibility derived from the fact that it was tacitly supported by the German government.
The world of ordinary monetary policy, however, is very different. A central bank may be able to guide expectations by pre-announcing a policy. Even that fails more often than it succeeds. Just remember the havoc the US Federal Reserve created when it raised the issue of tapering last year. When you try to fool too many people for too long, they stop believing you. In the case of the ECB and the more verbose national central banks, I fear this may already have happened.
It has been going on for five months. In October last year, inflation fell like a brick – to a little under 1 per cent. Both the drop and its persistence surprised the ECB. It cut interest rates in November. Since then, it has just been talk.
On Friday Spain reported outright deflation. Even German inflation is at only 1 per cent. One often hears the phrase that we are one shock away from outright deflation. It would have to be quite a large shock for that to happen. The Ukraine crisis could constitute such a shock but probably not in the absence of an extreme escalation. But it is aggravating the situation. Money from Russia and other places is streaming into the eurozone, raising the real exchange rate of the single currency and reducing import prices.
Quantitative easing is the only big policy tool left to do the heavy lifting. It would lift inflationary expectations. It would accomplish this through different channels. One of them is to get banks to sell assets to the ECB, the proceeds of which they would use to lend to companies. Another channel would be a fall in long-term interest rates.
On my own calculations, the total size of such a programme would have to be well over $1tn – but that number rises with each month of inaction. Marcel Fratzscher, the director of Germany’s DIW economics institute, came up with a number of $60bn per month, which is in the same ballpark.
It is showtime. No more talk. And please, no doctored minutes of meetings of the ECB’s governing council either, an “innovation” currently under discussion. It would only add to verbal overflow.
Instead, tell us that you have acted and why. Or, more likely, tell us that you have not acted, or have not acted enough, and why.
Copyright The Financial Times Limited 2014.
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