BlogSpot - October 6th, 2014
The ECB between prudence and effectiveness
At the latest Governing Council, Mario Draghi stressed the need for the ECB to work on preventing protracted stagnation. The debate is focused on the design of unconventional monetary policies (UMPs) and their size.
The debate on the effectiveness of the recently announced UMPs revolves around a number of issues:
The targeted size of the ECB’s balance sheet. According to Eurointelligence, there is uncertainty about the target itself, set by Mario Draghi (his press conference), i.e., the balance sheet size at early 2012 (about €3tn), with room for interpretation with smaller estimates. This comes after mixed success of the T-LTRO, as discussed in our previous WS BlogSpot. Ken Wattret (in the FT) warns that the ECB may fall short of reversing the shrinkage in its balance sheet. Prudence by the ECB will prevent active bank lending. Jürgen Stark, in a Project Syndicate article, supports on the contrary prudence until governments implement the structural reforms required to make monetary policy effective; when guarantying indebted countries’ sovereign bonds and non-performing loans weakens the willingness to reform.
The design of the purchase programs—expected to be as inclusive as possible to reinforce their impact (Reuters). Initial details were provided by the ECB on the Covered Bonds Purchase Program (CBPP) and the ABS Purchase Program (ABSPP)—including the confirmation of the sensitive issue of purchases of Greek and Cypriot senior tranches. As reported by Eurointelligence, the ECB will seek to neutralize risks in four ways: (i) a monthly reporting of the underlying credit pool, (ii) an over-collateralisation requirement of 25 percent, (iii) minimum rating for currency hedging for non-euro claims, (iv) claims must be against debtors domiciled in the eurozone. Additionally, derogation from collateral rules would require the targeted country to be under a financial-support program (Reuters). Silvia Merler (Bruegel) raises additional issues: the vagueness of the eligibility criteria for guaranteed mezzanine tranches of ABSs and the potential conflict of interest between purchases of bank bonds and supervisory roles.
The possibility of QE—analysts are commenting that QE will be necessary to reach the balance sheet target (see Eurointelligence) and prompted by a continued dire inflation outlook (James Mackintosh). Jacob Funk Kirkegaard (Perterson Institute) argues that caution on QE is warranted, especially as, without progress in reducing economic rigidities, exit from bond purchases is difficult.
The exchange rate channel of monetary policy—In FT Alphaville, Lorenzo Bini-Smaghi argues that the exchange rate channel will be central to the effectiveness of asset purchases—making success very dependent on expectations. For Christian Odendahl, given the weakness of the euro, its depreciation should be expected, supporting an export-led recovery rather than a mercantilist widening of the zone current account—though EuroIntelligence reminds us that the impact of German exports will likely be large, and mercantilist… (and targeted in the semi-annual US report on International Economic and Exchange Rate Policies as reported by Ian Talley).
Will Italy and Greece make it?
Recent developments on the periphery—the Italian debt ratio crossing 135 percent of GDP and the Greek government seeking an early exit from the troika program—called a host on questions on the immediate outlook for those countries.
Roberto Orsi, from the LSE Euro Crisis blog, writes that the analysts have become decidedly more pessimistic about the outlook for Italy. He takes the example of three recent articles, all asking whether Italy can get past its dangerous closeness with the debt trap. Wolfgang Münchau (in the FT) stresses that Italy has few of the policy levers needed to jump start economic growth—no devaluation, no printing press, no domestic interest rates, and structural reforms take time. Roger Bootle and Ambrose Evans-Pritchard (The Telegraph) call for “something big,” i.e., for the ECB to start buying government bonds on a massive scale. For Munchau, it requires strong coordination at the EU level, a test for the survival of the euro. Going further, Roberto Orsi points out Italy’s weak reform momentum and writes that default options are unattractive. He calls for a new monetary regime, with the introduction of a dual currency regime in certain Eurozone members and the redenomination of national debts.
Greece is discussing exiting the Troika program, amid political tensions, according to Keeptalkinggreece. The Economist notes that it may be too soon for Greece to dispense with the last round of handouts. Negotiations with Troika representatives have a number of difficult issues, including non-performing loans (Kathimerini), an extended repayment program for debts to the state, the approval of the fiscal targets in the draft 2015 budget, a new round of pension reforms and further liberalization of the labor market, according to Macropolis—issues with difficult political timing, according to Eurointelligence.
The Short View…
Partitocracy—Both Economic and Financial Commissioners struggled to convince a divided EP. Meanwhile UK Commissioner designate Lord Hill faced in a two-time hearing the European Parliament’s Economic and Monetary affairs committee for the proposed role of Financial Commissioner, reports Open Europe.
By Jonathan Thebault and Victor Estrade
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