BlogSpot - September 22nd, 2014
Questions about the ECB’s unconventional policy toolkit…
The new TLTRO program (introduced in June with two initial auctions in September and December 2014) was met with limited demand from banks. Joseph Cotterill (FT Alphaville) reports that the actual amount allotted was only 82.6 billion (mostly to Spanish and Italian banks), i.e. less than half the average expectation for this first operation. This was followed by an unexpected spike in the repayment rate of the old LTRO of nearly €20bn, according to Reuters—making the net amount raised virtually insignificant (see Nomura’s analyst report).
Silvia Merler, in a Bruegel opinion note, notes that rather than using very cheap liquidity, euro area banks are actually reimbursing it. She looks at potential explanations: wait-and-see with the comprehensive assessment of bank balance sheets; potential stigma (unlikely); uncertainty around the new ABS purchase program. Further, even borrowing cheaply to lend to risky SMEs may not be profitable for banks.
The ECB intends to expand its balance sheet back to crisis levels, i.e., by about 1 trillion euros—mostly through the TLTRO; possibly an irrealistic aim (see Richard Barley in the WSJ). For Merler, the low recent take-up shows the risk of doing a “(not so) unconventional” monetary policy à la ECB: it is ultimately outside the central bank’s control, because it is driven by banks’ demand. David Keohane (FT Alphaville) also underscores (based on a BofAML report) the limits of relying on demand to drive central bank balance sheet expansion.
These developments put a lot of attention on the new ECB tool: ABS purchases, with several issues under discussion, while details of the program to be announced next month. For EuroIntelligence, the disappointing take-up rate for the TLTRO shifts the balance in the ECB’s policy tools firmly towards asset purchases. One key issue is the possibility of State guarantees to cover ECB purchases of mezzanine debt. The Franco-German response to this request is a mixed rejection: "An intervention in the form of a public guarantee scheme would be problematic, because the investors could then rely on the warranty, instead of the transaction and its underlying values not to undergo a thorough examination,” with some analysts point to the lack of sufficient control systems at the ECB. Speculation also focuses on ECB’s intention to buy ABS which it currently does not accept as collateral. EuroIntelligence stresses that these arguments are misleading in assuming the ECB would accumulate high risk assets.
More broadly, there is an increasing number of observers arguing that liquidity injection may not be the right solution, as whatever causes the credit crunch in large parts of the eurozone is no longer fundamentally a question about constrained supply, but is demand-driven, as argued by Daniel Gros, Cinzia Alcidi and Alessandro Giovannini in a CEPS draft paper.
Time to act, and this requires investment…
A window of opportunity is open for decisive action in the eurozone. In a Brookings paper, Luigi Guiso, Paola Sapienza and Luigi Zingales argue that the construction of the euro is facing risks of serious reversals—and that the exit of one country would endanger many European achievements. Wolfgang Munchau also comments on risks to the political clout of Europe in the world, and writes that, absent a solution to the sustainable of the euro, its role in the world will gradually diminish. Analysts see a window of opportunity for packages of wide-ranging reforms, with the new European Commission taking shape. Michael Spence, in Project Syndicate, argues that eurozone countries should implement fiscal and structural reforms in exchange for short-run relaxation of fiscal constraints – not to increase liabilities, but to focus on growth-oriented investments to jump-start sustained recovery—supported by private investors. Kemal Dervis (Project Syndicate) underscores that achieving key structural reforms (some combination of tax, labor-market, service-sector, and education reforms, as well as reforms in territorial administration) requires a thoroughly revamped social contract, modernized yet adapted to Europeans’ commitment to distributive fairness and political equality. Both stress the importance of enacting such reforms sooner rather than later.
Roberto Perotti (VoxEU) writes that that there are no short-cuts, the only feasible alternative to achieve the overarching goal for the medium term – reduce taxes – is to cut taxes together with spending. This process will take time, and will work incrementally, but it is the only realistic approach. The alternative would defeat its purpose of increasing aggregate demand.
Simon Wren-Lewis, on MainlyMacro, reopens the debate on fiscal austerity and argues that the solution for the eurozone is a symmetric set of constraints, with a fiscal union to impose fiscal stimulus on Germany. He writes that while the case for additional infrastructure spending in Germany looks strong, as argued by Marcel Fratzscher, Germany should take part in a Eurozone wide program of additional public investment, which can be justified on a microeconomic/supply side basis as well as on macroeconomic/demand side grounds. All that stands in the way is the power of bad ideas, and its embodiment in the Eurozone’s fiscal rules. Another example of Germany’s reluctance to engage into such investment spending policies is its immediate refusal of using the ESM as an investment fund (hat-tip EuroIntelligence). According to Suddeutsche Zeitung, Juncker was actively considering turning the unused capacity of the ESM into a credit facility to help boost EU investments, supervised by the EIB. Wolfgang Schauble immediately dismissed the proposal on the grounds that the use of these funds was not backed by the ESM treaty.
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