Whatever it takes
The European QE: whatever it takes to succeed
The ECB will do all it must to raise inflation to the target rate (see Mario Draghi’s Frankfurt speech, anticipated with previous speeches, as reported by Eurointelligence and Bloomberg)—with expectations that more QE is coming (FTAlphaville and LesEchos).
Expectations are high for this week’s ECB policy decision. Tobias Ruhl (UniCredit) thinks the policy meeting is very likely to see the announcement of further important easing measures—a package including a 10-15bp cut in the deposit rate and additional asset purchases of about EUR 500bn, with the monthly pace of asset purchases raised from EUR 60bn to about EUR 75bn. All triggered by a new set of macroeconomic forecasts.
While the ECB assures that QE has been a success and it just needs recalibration, some economists showcase data that reveals that it has boosted neither growth nor inflation. Furthermore, they state that periphery bond yields have been steadily declining since 2012 (Borse.it), with QE having an insignificant effect on the trend. Guntram Wolff (Bruegel) brings some distance in the monetary policy debate, showing that, while the ECB is criticized by some (especially in Germany) for its low interest rate policy, real interest rates have been falling since the 1980s. Yet the real interest rate has risen recently, leaving the ECB no choice but to extend its program. For Wolff, politics has to deliver on long-needed structural reforms and foster growth through sensible investments, in particular regarding refugees.
QE efficiency is reduced due to several factors, according to Ecomonitor: first, sovereigns missed the opportunity to associate QE with expansionary fiscal policy; second, the vast majority of money supply has gone to feed the public sector, hence increasing euro area government indebtedness; finally, the policy did not ease credit for households and corporates.
The presence of a liquidity trap is a real concern, with various policy options to address it. For Adair Turner, it contributes to slow GDP growth, as there is (i) no more space for conventional policies to boost demand, and (ii) reduced possibility for global asset markets to clear because of excessive demand (R. Caballero, P.O. Gourinchas, E. Fahri). Caballero and al, L. Summers propose fiscal expansion as an efficient way of overcoming liquidity traps. For Benoit Cœuré (speech), economic policy should be reconsidered. The lack of investment along with low interest rates creates a vicious circle. With monetary policy overburdened (BusinessSpectator), focusing on supply side measures is crucial according to Cœuré. Smart integration of refugees into European economies coupled with deficit-financed investments, could actually help exit the liquidity trap, by helping to increase the equilibrium real interest rate, as argued by Guntram Wolff (Bruegel).
The European Deposit Insurance Scheme: the Weakest Link?
The Commission recently proposed a euro-area wide insurance scheme for bank deposits as the third step for completing the Banking Union—to buttress bank depositor protection, reinforce financial stability and further reduce the link between banks and sovereigns.
The plan is a reinsurance scheme that would back up national schemes until 2020 (a national DGS could access EDIS funds only when it has exhausted own resources, as defined by the minimum level required in the DGS Directive and the contribution from EDIS would be capped), followed by a gradual process of mutualisation between 2020 and 2024 (national DGS would not be required to exhaust own resources before accessing EDIS funds; the share contributed by EDIS will start at 20 percent and increase gradually to 100 percent in 2024), and a single European scheme in 2024 with a fund of €45bn (where EDIS would fully insure deposits and cover all liquidity needs and losses of a depositor payout or resolution procedure) (see EuroIntelligence). The management of the EDIS will be entrusted to the Single Resolution Board.
To alleviate concerns about risk-sharing, the EC is proposing risk-reduction measures. It will press countries to ratify the inter-governmental agreement for the Single Resolution Fund and transpose the BRRD and DGS Directive.
The proposal appeared as lacking ambition, driven by German reluctance. The German view is that the focus should not be on mutualising but on minimising risks. For Paul Krugman, this is another reflection of Europe’s lack of political will. In particular, the muted proposal reflects the German concern that the EDIS would be a hidden risk mutualization, as banks hold too much sovereign bonds (German Bundesbank and Eurointelligence). A German government official (Financial Times) noted that the scheme sets "wrong priorities and guidelines" and that it would spread risk around the Eurozone rather than reduce it. Claudia Buch and Andreas Dombret argue that it makes no sense to have a European deposit insurance scheme for as long as national politics dominates the financial sector. Forcing caps on bond holdings right now would be destabilizing for sovereign debt markets.
The European Banking Federation expressed its concern about the process and pace for the introduction of the scheme—with concerns about potential increases in overall contributions that banks make to deposit guarantee systems. As highlighted by Bloomberg, the EU will have time to consider all the opinion, since it will take a decade to build EDIS.
The short view(s)…
The Irish “Renaissance”: The Irish economy is growing at an unprecedented speed, just 2 years after its bail-out, due to (The Economist): (i) its status as a platform for multinationals, (ii) its close trade ties with dynamic economies of the US and UK; and (iii) lower energy prices. Reform initiatives (Antonio Fatás), fiscal adjustment and bank stabilization policies (Dirk Schoenmaker) helped (see IMF conference).
Italy’s zero-cost bailout is too good to be true: The creative bailout plan to resolve the accumulation of bad loans in Italy is criticized, with the claim that it will come at zero cost to taxpayers is hard to believe (FinancialTimes and Reuters).
The ECB’s financial stability review: worried about external instability. Mostly through investment funds, rather than bank exposures (EuroIntelligence)—with spillovers through lower asset valuations and an increase in money market funding costs. A special feature in the ECB's financial stability report addresses the concern that a leverage ratio limit encourages risk-taking, but the authors find that the increased loss-absorbing capacity from reduced leverage outweighs the increased risk of losses from the assets themselves.
