Another missed opportunity in the EU’s monetary mess

Lack of proper euro government bond market is why euro experiment is a mess

The euro sculpture outside of the European Central Bank building in Frankfurt. Photograph: Arne Dedert/EPA

The euro sculpture outside of the European Central Bank building in Frankfurt. Photograph: Arne Dedert/EPA


Mario Draghi’s latest cuts in interest rates are virtually unprecedented. Danish and Swedish central banks have flirted with similar moves but the European Central Bank’s decision to charge banks for the right to park their spare cash in Frankfurt is the first time a major central bank has attempted such a bold step.

For all of the so-called quantitative easing (QE) undertaken by the Bank of Japan, US Federal Reserve and the Bank of England, none has tried that particular trick. They have preferred to buy bonds issued by their respective governments.

There are lots of reasons why the ECB won’t buy European government bonds but, conceptually, the right way to think about this gets to the core of the problem: there are no European government bonds to buy, only German, French, Greek and 15 other separate sovereign bond markets. And until there are proper euro bonds issued at the federal European level there will be no orthodox QE from the ECB.

The lack of a proper euro government bond market is really why the whole euro experiment is in such a mess.

Politically, buying Irish or Spanish debt is clearly a problem for the ECB. So it is looking at buying other bonds, typically issued by corporations, called Asset Backed Securities (ABS).

This is not a bad idea: in the circumstances facing the ECB, buying assets of all kinds is actually a very sensible thing to do. The trouble is that the European ABS market is possibly too small for any buying programme to have a material macroeconomic effect.

In any event, the ECB should be doing it now, not just having yet another think about it. The suspicion is that they are looking at the ABS market as a last resort, one that is not yet palatable in Germany.

Too little

Given the lack of historical experience with negative interest rates, we need to be even more cautious than usual when making forecasts about what might happen next. But there are plenty of reasons for thinking that it will, yet again, be a case of too little, too late.

As a matter of fact, banks lately have been reducing their deposits at the ECB, so the practical impact looks likely to be small. Psychology is also important: will negative interest rates spur banks to lend more? Will they prompt companies to boost their capital spending?

At the margin, lower interest rates plus the extra liquidity measures announced yesterday should help to increase corporate borrowing. Again, it is hard to see major effects. Like it or loath it, but QE in the US and Britain has worked partly via a boost to the residential property market. The rules underlying the cash injections promised by the ECB are explicitly designed to be channelled anywhere but the mortgage market.

This might seem wise, in that property bubbles caused a lot of the peripheral economic problems in the first place. But there is also a whiff of puritanism about this: we want growth to resume but not in the way Britain and US have done it. Holding our noses over the possibility of boosting the European residential property market is an economic snobbishness we can’t afford.

Making extra cash available for SME borrowing is all very fine and noble. But such activities do not get to the heart of the problem: the failure of the ECB to fulfil its mandate, namely to achieve an inflation rate below, but close to, 2 per cent.

The ECB’s current projections see inflation gently rising from its current rate of 0.5 per cent to 1.6 per cent by 2016. No doubt it will claim that if this happens it amounts to inflation hitting the stated target. The risks are clearly that we get nowhere near 1.6 per cent and even if we do it is an abuse of the language to claim that is “job done”.

Central banks, if they have enough determination, can generate as much, or as little, inflation as they want to. They just have to try hard.

The suspicion is that the Germanic influence at the ECB reduces any sense of urgency about hitting the inflation target. Achieving 2 per cent inflation is a merely technical matter of proper monetary policy; there is nothing mysterious or hard about how to achieve it.


Of course, a 2 per cent inflation rate will not solve all of Europe’s problems: too much is sometimes expected of our central bankers. But positive inflation will provide some much needed assistance to debt- strapped economies. Because those economies have near-zero or even negative inflation, an average euro-area rate of 2 per cent requires a German inflation rate well in excess of 2 per cent. The delivery of relatively high German inflation is technically feasible but politically probably impossible.

That’s another fundamental contradiction that cripples the proper functioning of the euro zone.

The ECB stated with admirable clarity that it considers economic risks to lie to the downside. That’s the cover for yesterday’s unanimous policy decisions. Yesterday was also the anniversary of the birth of John Maynard Keynes, who would probably be astonished by the low level of economic debate that takes place in Europe and the resulting serial policy errors.

In the 1930s it took an intellectual revolution prompted by Keynes to persuade policymakers that demanding all of the major sectors of the economy, public and private, to reduce spending and increase saving was not such a good idea in the middle of a major depression.

We are essentially replaying those debates but without a modern-day Keynes to point out the folly of it all.

A half-baked monetary union that cannot even deliver relatively easily attained inflation targets will not survive. There is still time and scope to make things more sustainable but Europe never misses an opportunity to miss the opportunity.

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