European Central Bank President Mario Draghi speaking at the economic and monetary affairs Committee of the European Parliament last Monday, made at least two direct references to additional monetary measures, to confront the anaemic economic conditions in Eurozone, “if warranted to achieve price stability over the medium term”. He referred to this prospect once while delivering his introductory speech at the hearing of the Committee and secondly when addressing a MEPs’ questions. He also clarified that, “we have also tasked relevant ECB staff and Eurosystem committees with the timely preparation of further measures to be implemented, if needed”.
With ECB’s Governing Council having already decided to effectuate acquisitions of asset-backed securities and covered bonds, the next monetary policy step in this quantitative easing line of measures, cannot be anything else other than the outright purchases of corporate and government bonds. Even more revealing was the intervention of Klaas Knot, a member of the ECB’s Governing Council and President of the Dutch central bank, De Nederlandsche Bank. Last Tuesday Knot said that the ECB may well take additional quantitative easing measures, “including purchases of government bonds”.
Printing new money
Of course, all these ECB policy steps end up to printing of new money, which is handed out to lenders. The exercise is realised through central bank purchases (against freshly printed cash) of securitised bank loans or of large parts of the lenders’ stock of corporate and government bonds. This bold policy has been freely applied during the past six years by all the major central banks of the world, and more importantly in the US (Fed), in Britain (Bank of England) and Japan (BOJ). Their target was and of course still is to revive the faltering real economy, in the aftermath of the 2008-2010 financial crisis, by means of printing and freely distributing money.
Unlike what happened in the rest of the developed world, the ECB under the influence of its largest member the German central bank (the Bundesbank), avoided following the same policy lines. As it turned out, the US and Britain, extensively using this policy of quantitative easing during the past years, have actually helped their real economy grow albeit moderately. Most importantly they have managed to progressively reduce unemployment to tolerable single digit levels.
On the contrary, Eurozone still suffers from recession or stagnation, with skyrocketing unemployment. This has brought a number of its member states to their knees, actually testing the limits of their social endurance and unsettling their political life. The appearance of Eurosceptic, extreme and even clownish political parties is the direct outcome of this process.
The danger of deflation
On top of economic stagnation and high unemployment, the next major strain Eurozone currently endures is the falling inflation rate, currently at 0.4%, very close to absolute zero, in contact with the frightful negative part of the chart. This is much lower than ECB’s institutional target of below but close to 2%. According to the same source, inflation in the foreseeable future will remain at considerably lower levels than the institutional target. Obviously this fact obliges the central bank to take action and support inflation to reach the target.
This reality has armed Mario Draghi with a very solid argument against the austerity-loving and monetary-easing-hating Germans. Under the circumstances, Draghi can even contemplate the printing and the distribution of a full additional trillion of euros to be partly used to purchase corporate and government bonds. He almost said this plainly by stating that the Governing Council has mandated the staff of the ECB “with the timely preparation of further measures”. The next step, after the acquisition of ABSs and covered bonds, is the purchases of corporate and government bonds.
Draghi reassured the MEPs
That’s why Draghi, in his regular monetary dialogue with European deputies responsible for economic and monetary affairs, reiterated that the “ECB’s balance sheet could go up to the level of March 2012 if needed”. This is a direct reassurance for the forthcoming printing of an additional trillion euro. When asked whether this was a target or an expectation, he said that “it is an expectation” and added that “if not fulfilled, other measures might be taken”. The next day Knot explained that the purchases of sovereign debt may be included in these “other measures”.
Expectation or target?
The question about ‘target’ or ‘expectation’ was addressed to Draghi by a German MEPs. Here is why. Last week, Jens Weidmann, the Governor of the German central bank, the Bundesbak, termed the policy action (to increase ECB’s balance sheet by one trillion) unanimously endorsed by ECB’s Governing Council (including him), as an ‘expectation’ not a ‘target”. Of course this is always in reference to the one trillion to be printed and distributed to banks. Draghi though paid lip service to what Weidmann had said, because he clarified that “if not fulfilled (the printing of one trillion), other measures might be taken”. Then the trillion is evidently becoming a clear-cut target, not an expectation. Expectations are not targeted with additional measures until being fully achieved, only targets do.
After that, Weidmann must be in a very awkward position. It is understood that even the Berlin government doesn’t any more back his ultra-orthodox beliefs, that the central banks should not support the real economy with monetary easing. Berlin is now obliged to think in more ‘European’ terms, that the Bundesbank still cannot understand.
For similar reasons, Axel A. Weber, Weidmann’s predecessor, had quit and Berlin had accepted his resignation without much grief. However, Weidmann hasn’t followed Weber’s example, despite Draghi having ignored him more than once, and still Berlin didn’t seem to bother. This is rather a sign that Germany slowly changes, accepting that the country has to adapt to the needs of others, grasping that the German way is not the only available path.
Over the next months the situation will be cleared up, when the ECB starts to purchase corporate and government bonds, helping the south of Eurozone to cut down the cost of servicing its debts and find new and cheaper capital resources.