ECB should offer more and cheaper liquidity if Eurozone is to avoid recession

The fact that monetary policy is the only common policy applied invariably in the 18 still widely diverging Eurozone economies, means that the European Central Bank is the unique euro area institution, which thinks and acts on a really European level. In this respect, the latest statements by its President, Mario Draghi, are quite pertinent. After he recognised that growth in Eurozone is “weak, fragile and uneven”, he reassured everybody that ECB will do its utmost to help euro area’s economy grow again, by keeping its interest rates at their present or lower levels and continue offering abundant liquidity to Eurozone banks. This first time ever, so detailed and clear ‘forward guidance’ by the ECB obviously means, that in the central bank many people don’t believe Eurozone has abandoned the recession path it followed for the last three years. Consequently the 0.3% increase in Eurozone’s GDP during the second quarter of 2013 may soon be pointing southwards again. Optimism turns sour Given the above, the optimism expressed by some European dignitaries in Brussels, after the announcement of a 1% increase in Eurozone’s industrial production in August, may be considered as an exaggeration. For one thing, during July, industrial production had shrunk by another percentage unit. Let alone that on a twelve month base, in August 2013 compared with August 2012, industrial production dropped by 2.1% in the euro area. Apart from Eurozone’s negative internal economic prospects, any help from the rest of the world, in the form of a rise in demand, should also be considered as highly improbable. After the 17 days shutdown of the administration, the American economy is thought to have lost some of its already weak momentum. As for the developing countries, only China seems to be able to reach the GDP increase target this year, set at 7.5% by Beijing planners. Concerning the rest of the developing countries, IMF economists, Kalpana Kochhar and Roberto Perrelli, in their study entitled, “How Emerging Markets Can Get Their Groove Back”, give a rather frightening response to their own question. They concluded as follows, “we estimate that emerging market’s potential growth needs to be revised down”. If one adds to all that the problems stemming from the dangerously inadequate capitalisation of Eurozone’s banks, and the consequent reduction of available finance for businesses and households, then the entire euro area looks rather bound to return to recession, than gain a new sustainable growth path. Of course there are more dimensions to euro area’s financial shortcomings. Saved by liquidity In view of all those problems ECB cannot stay idle. It is the only institution disposing strong common economic policy tools, targeted invariably on all 18 Eurozone member states. However, this is not the only impetus for ECB to take action. Even its currently applied monetary policy doesn’t reach all member states. The availability of credits and the interest rate cost of bank loans vary largely between member states, to levels that are not justifiable by structural differences. An infallible witness of that is the triple interest rate cost for similar business risks charged by lenders to SMEs in the south, compared to their peers in core Eurozone countries. This is the famous or rather infamous transmission problem of ECB’s monetary policy, recognised by everybody as a major impediment not only to Eurozone’s integration process, but to achieving even a decimal GDP increase. In short, the cheap and ample liquidity now offered by the ECB doesn’t reach all the member states. Greek, Italian, Spanish, Portuguese and Irish SMEs pay much dearer for the same risks, if finally they come upon a loan offer. This said, many European economists think that the only way the ECB can react to this adverse conjuncture is to further reduce its basic interest rate and offer more liquidity to Eurozone banks. At this point it must be noted that last year ECB offered more than one trillion in two Long Term Refinancing Operations (LTROs), to the 6,000 lenders of the euro area. Those loans had three year maturities and a 0.5% interest rate. That given, the new LTROs needed badly in Eurozone should obviously be of longer maturities and of lower interest rates. This move will also facilitate some Eurozone sovereign borrowers to secure more and cheaper loans they desperately need. In short, the ECB is now almost obliged to print and distribute more money all over Eurozone. All euro area banks along with the southern countries and the SMEs need more and cheaper liquidity. This is not only a prerequisite for growth, but now has become a necessity to avoid more recession.