Can ECB’s €60 billion a month save Eurozone?

Jyrki Katainen, Vice-President of the EC in charge of Jobs, Growth, Investment and Competitiveness (on the left), and Pierre Moscovici, Member of the EC in charge of Economic and Financial Affairs, Taxation and Customs, gave a joint press conference on the autumn economic forecasts for 2014-2016. Real GDP growth is estimated at 1.3% in the EU and 0.8% in the euro area for 2014 as a whole. Growth is expected to rise slowly in the course of 2015, to 1.5% and 1.1% respectively, while an acceleration of economic activity to 2.0% and 1.7% respectively is predicted for 2016. Understandably growth expectations are always inflated in deflationary times by the politicians ‘in charge’ Unfortunately for them the future quickly becomes a disappointing present. (EC Audiovisual Services).

The European Central Bank as from this March will start pumping into the Eurozone economy extra liquidity of €60 billion a month of freshly printed money. The details of this extraordinary policy measure will be revealed tomorrow Thursday by Mario Draghi the President of ECB, in his regular Press conference after the Governing Council meeting which is to be convened this time in Cyprus. This is the last-ditch shot to perk up growth and reverse the very low or negative inflation rates that prevail in euro area. In detail, according to the celebrated 22 January announcement by ECB’s Governing Council, the euro area central bank is expected to commence its “expanded asset purchase program to include bonds issued by euro area central governments, agencies and European institutions”.

Purchases of such securities will amount to €60bn a month and the program is “intended to be carried out until at least September 2016” or until the headline inflation reaches the institutional target of close to 2%. Currently annual inflation has plunged to the negative area of the chart. But is the euro area economy ready to take full advantage of that? Or, are the banks in a position and willing to pass this new money bonanza to the real economy? Let’s try to answer these questions.

Can the banks do it?

According to the eligibility criteria as they have been set by the ECB, state bonds to be purchased must have a “minimum remaining maturity of 2 years and a maximum remaining maturity of 30 years”. Understandably, this condition forbids direct government financing with ECB money, as dictated by the central bank statutes. At the same time it also means though that all those purchases of bonds will be effectuated in the secondary markets, and quite predictably all the large systemic banks won’t miss the opportunity to unload a good part of the government debt they hold for cash and transfer it to the central bank.

Not to forget that almost all the systemic euro area banks are thirsty for quick profits, that can boost their meager own capital reserves. Invariably then they will all be tempted to use this extra cash for risky ‘investments’ in the shadow banking universe which could fetch high returns. This is a ‘game’ the big lenders know very well because they have invented it themselves. This is exactly what brought the developed world to its knees during the 2008-2010 financial melt-down. By the same token almost all the major euro area banks have developed anorexia for their traditional trade of lending money to the real economy and the SMEs.

Where will all that money end up?

There is more to it though. In the face of it, this new extraordinary liquidity injection is theoretically directed mainly to those euro area countries, where ECB’s years long cheap money policy is partially or not at all transmitted. Therefore an easing of financial conditions is mostly needed there. As a matter of fact though the transmission mechanism of this new ECB extraordinary measure remains the same and comprises exclusively the lenders in those member states.

Unfortunately the banks in the crisis stricken south Eurozone nations and Ireland are in a much worse position than their counterparts in the core euro area countries. Consequently their ability to support the real economy by lending money to businesses and consumers is thus very much questionable. So, in those member states it will be a high risk bet if the new ECB liquidity will end up supporting the real economy. It is questionable then if “the institutions that sold the securities can use…the central bank money…to buy other assets and extend credit to the real economy” as the ECB maintains.

The demand side for loans

Now let’s turn to the economy’s ability to take full advantage of the new money injections or to put it differently, the demand for loans side. Fortunately in this respect it seems that something started moving in the right direction. The first good news for quite some time broke out last Monday, when the Eurtaost, the EU statistical service announced that the February inflation rose to -0.3% from -0.6% in January. It might be just three decimal points of a percentage unit but it represents a write off of half the previous negative inflation reading.

Some inflation needed

As every first year student of economics knows, a bit more inflation means a bit more growth albeit nominal. However in the current conjuncture the cliché may be rephrased to ‘let it be growth even if it is in nominal terms’. Nobody can be hurt by a few percentage units of inflation if it is accompanied by real growth. Not to forget that the Eurozone grew by a positive 0.3% during the fourth quarter of 2014, and at that time inflation was also positive around 0.2%. This means that growth by no means is to trigger inflation in Eurozone. The inverse is actually true that is some inflation would help growth, despite the Teutonic cathexis for the opposite.

So let’s hope that those €60bn a month from the ECB, injected into the euro area economy, even in a restricted way, will awake the price system by bringing about some more demand and in this manner enliven real growth.