Christine Lagarde must guide ECB through uncharted and troubled waters
Bank chief must fathom threats far deeper than inflation and monetary policy
Christine Lagarde accepts a ceremonial bell from outgoing president of the European Central Bank Mario Draghi. Photograph: Alex Kraus/Bloomberg
When Christine Lagarde takes over as president of the European Central Bank for an eight-year term on Friday, she will become the first woman to hold this position since the ECB was founded in 1998.
This is not Lagarde’s only first. She was also the first female minister for finance in a G7 country when she was appointed to that role in France in 2005. She was also the first woman managing director of the International Monetary Fund and the the first female chair of international law firm Baker & McKenzie.
Radical changes are unlikely. Lagarde, like her predecessor Mario Draghi, favours low interest rates designed to encourage economic growth.
She is on record as agreeing with the ECB’s current policy of low interest rates to stimulate the euro zone economy and push inflation towards the bank’s target of 2 per cent a year.
When she spoke in front of the Economic and Monetary Affairs Committee of the European Parliament, (which voted for her candidacy) in September, she said the current “highly accommodative policy stance is warranted for a prolonged period of time in order to bring inflation back to below but close to 2 per cent”.
However she faces a number of challenges as she takes up her new role.
The ECB cut deposit rates to negative 0.5 per cent on September 3rd. This means that banks face a bill for depositing funds with the ECB, and is intended to encourage them to lend the money instead – to boost demand and also inflation.
But the opposite could occur. This interest rate bill hurts banks’ profitability. They may decide to hoard cash in vaults and reduce lending. Lagarde will need to be careful not to overpenalise banks and push them towards this counterproductive behaviour.
There is much disquiet about low and negative interest rates across the euro area. Several former central bankers, including Otmar Issing and Juergen Stark – former members of the ECB’s executive board – expressed this concern in a signed memorandum on ECB monetary policy on October 4th. In particular, they point out that very low interest rates favour people who hold real assets like property and hurt those who wish to, for example, save for old age.
Then there’s quantitative easing. This involves the ECB buying government and corporate bonds in order – once again – to spur inflation by pushing down the cost of borrowing .
The last quantitative easing programme saw the purchase of more than €2.5 trillion worth of bonds between 2014 to 2018. When the programme ended, the ECB said they would also increase interest rates in 2019 and gradually reverse the easy monetary policy that had prevailed.
The recent slowdown in economic activity, and risks due to Brexit and the US-China trade war, have prompted the ECB to start a new quantitative easing programme
But much has changed since then. The recent slowdown in economic activity, and risks due to Brexit and the US-China trade war, have prompted the ECB to start a new quantitative easing programme this month. The bank will begin buying €20 billion worth of bonds a month, and that programme also begins now. What’s more, they have signalled that this will continue for some time.
Again, there are many critics of quantitative easing. Issing and others argue that continued government bond purchases by the ECB will not boost growth. There are also concerns these bond purchases may lead to asset bubbles as banks may move away from safe assets like government bonds to riskier assets with higher expected returns like company bonds or shares. This, in turn, may push up demand for company bonds and shares and push their prices beyond their real value. We all know what happens to asset bubbles.
Lagarde has to get the quantity and timing of asset-buying right. Too little and she risks inflation persistently below the ECB’s target, too much and she risks destabilising the financial system.
And that’s just monetary policy. Lagarde and her colleagues will also have to face up to a range of emerging risks in the financial sector.
Should the ECB create its own digital currency to help ensure money creation stays in the hands of public institutions?
Facebook plans to launch Libra, a blockchain digital currency, next year. While this initiative may have lost its shine in recent months, digital currencies are here to stay. Should the ECB respond by creating its own digital currency, thereby helping to ensure money creation stays in the hands of public institutions?
How will climate change mitigation policies and people’s changing preferences affect the energy, transport, manufacturing and construction sectors? Are the financial institutions exposed to a fall in the asset prices of carbon-intensive sectors? Have these risks been priced in? Should the ECB carry out green stress tests on euro area banks and if so, how?
These are uncharted and troubled waters.
Marie Finnegan is a lecturer in economics at GMIT