As we saw in the blog post last month, Eurozone becalmed the doldrums, the eurozone economy is stagnant and there is a growing danger that it could sink into a deflationary spiral. Last month, several new measures were announced by the ECB, including a negative interest rate on money deposited in the ECB by banks in the eurozone. This month, the ECB has gone further including, for the first time, a form of quantitative easing.
So what has been announced, and will it help to kick-start the eurozone economy? The measures were summarised by Mario Draghi, President of the ECB, at a press conference as follows:
The Governing Council decided today to lower the interest rate on the main refinancing operations of the Eurosystem by 10 basis points to 0.05% and the rate on the marginal lending facility by 10 basis points to 0.30%. The rate on the deposit facility was lowered by 10 basis points to –0.20%. In addition, the Governing Council decided to start purchasing non-financial private sector assets.
The Eurosystem will purchase a broad portfolio of simple and transparent asset-backed securities (ABSs) with underlying assets consisting of claims against the euro area non-financial private sector under an ABS purchase programme (ABSPP). This reflects the role of the ABS market in facilitating new credit flows to the economy and follows the intensification of preparatory work on this matter, as decided by the Governing Council in June. In parallel, the Eurosystem will also purchase a broad portfolio of euro-denominated covered bonds issued by MFIs domiciled in the euro area under a new covered bond purchase programme (CBPP3). Interventions under these programmes will start in October 2014.
To summarise: the ECB has cut interest rates, with the main rate cut to virtually zero (i.e. 0.05%). This represents a floor to interest rates, as, according to Mario Draghi, there is now no scope for further cuts. (Click here for a PowerPoint of the chart.)
In addition, the ECB will begin the outright purchase of private-sector securities. This is a form of quantitative easing as it will involve the purchase of assets with newly created money. In the past, the ECB has simply offered loans to banks, with assets owned by banks used as collateral. This form of quantitative easing has been dubbed ‘QE light’, as it does not involve the purchase of government bonds, something the German government in particular has resisted. The ECB recognises that it would be a sensitive matter to buy government bonds of countries, such as Greece, Spain and Cyprus, which have been criticised for excessive borrowing.
Nevertheless, if it involves the creation of new money, purchasing private-sector assets is indeed a form of QE. As Mario Draghi said in response to a question on this matter:
QE is an outright purchase of assets. To give an example: rather than accepting these assets as collateral for lending, the ECB would outright purchase these assets. That’s QE. It would inject money into the system. Now, QE can be private-sector asset-based, or also sovereign-sector, public-sector asset-based, or both. The components of today’s measures are predominantly oriented to credit easing. However, it’s quite clear that we would buy outright ABS only if there is a guarantee.
So with appropriate guarantees in place about the soundness of these securitised assets, the ECB will purchase them outright.
But will these measures be enough? Time will tell, but there are now several measures in the pipeline, which could see a large stimulus to bank lending. The main question is whether banks will indeed take the opportunity to lend or merely hoard the extra reserves. And that depends in large part on the demand for credit from businesses and consumers. Boosting that is difficult when the economic climate is pessimistic.
Articles
Draghi’s ECB surprise puts off bigger quantitative easing for now Reuters, John O’Donnell (5/9/14)
ECB President Mario Draghi pulls stimulus lever at last, but still no quantitative easing for eurozone Independent, Ben Chu (5/9/14)
ECB cuts rates and launches stimulus programme BBC News (4/9/14)
Draghi Push for ECB Easing Intensifies Focus on ABS Plan Bloomberg, Stefan Riecher and Jeff Black (4/9/14)
Draghi Sees Almost $1 Trillion Stimulus as QE Fight Waits Bloomberg, Simon Kennedy (5/9/14)
Draghi’s Case For ECB Quantitative Easing Forbes, Jon Hartley (8/9/14)
ECB’s last roll of the dice BBC News, Robert Peston (4/9/14)
Draghi’s eurozone steroids BBC News, Robert Peston (2/10/14)
Draghinomics – Abenomics, European-style The Guardian, Nouriel Roubini (1/9/14)
ECB Press Release
Introductory statement to the press conference (with Q&A) European Central Bank, Mario Draghi, President of the ECB (4/9/14)
Webcast of the press conference 4 September 2014 European Central Bank, Mario Draghi, President of the ECB (4/9/14)
Questions
- Summarise the ECB’s monetary policy measures that will be coming into effect over the coming months.
- How does the QE announced by Mario Draghi differ from the QE that has been used by the Bank of England?
- Would it be a realistic option for the ECB to reduce its main rate below zero, just as it did with the deposit facility rate?
- What is meant by ‘securitisation’. Explain how asset-backed securities (ABSs) and covered bonds are forms of securitised assets.
- Why will the purchase of mortgage-backed securities not necessarily give a boost to the housing market?
- How does the effectiveness of any QE programme depend on what happens to the velocity of circulation of created money?
- What determines this velocity of circulation?
- Why are ‘animal spirits’ so important in determining the effectiveness of monetary policy?
- Are there any moral hazards in the ECB actions? If so what are they?
The eurozone recorded 0.0% growth in the second quarter of 2014. While the UK and USA are now experiencing relatively buoyant economic growth, the eurozone as a whole is stagnating. Some of the 18 eurozone countries, it is true, are now growing, including Spain, Portugal, Ireland and the Netherlands. But the German and Italian economies contracted in the three months to the end of June, while France experienced zero growth.
This will put growing pressure on the ECB to introduce quantitative easing (QE) through the direct purchase of government bonds or other assets. Although this has been a key policy of many central banks, including the Bank of England, the Fed and the Bank of Japan, up to now the ECB has focused mainly on providing cheap funds to banks to encourage them to lend and keeping interest rates very low.
In June, the ECB did announce that it would explore the possibility of QE. It would also introduce €400 billion worth of targeted long-term lending to banks (targeted longer-term refinancing operations (TLTROs)), and would cease sterilising the extra liquidity injected through the Securities Markets Programme, which involved the purchase of existing bonds on the secondary market.
These plans and their implications are examined in the blog post, The ECB: tackling the threat of deflation.
But even if it does eventually introduce QE, this is unlikely before 2015. However, the first €200 billion of TLTROs will be introduced in September and the remaining €200 billion in December. The ECB hopes that these measures in the pipeline will give a sufficient stimulus to rekindle economic growth. But increasingly there are calls for something more dramatic to be done to prevent the eurozone as a whole slipping back into recession.
Articles
Eurozone economy grinds to halt even before Russia sanctions bite Reuters, Michelle Martin and Martin Santa (14/8/14)
ECB under pressure to boost growth, analysts say BBC News (14/8/14)
Eurozone growth at zero as Germany slumps, France stagnates Deutsche Welle (14/8/14)
Eurozone crisis: The grim economic reality BBC News, Gavin Hewitt (14/8/14)
Eurozone growth splutters to a halt as crisis enters new phase The Guardian, Larry Elliott (14/8/14)
Eurozone can learn from George Osborne and Bank of England stimulus The Guardian, Larry Elliott (14/8/14)
Broken Europe: economic growth grinds to a standstill The Telegraph, Szu Ping Chan (14/8/14)
One-in-three chance the ECB conducts quantitative easing next year – Reuters Poll Reuters, Sumanta Dey (13/8/14)
Eurozone’s Unravelling Recovery: What’s Going Wrong Across Troubled Currency Bloc International Business Times, Finbarr Bermingham (14/8/14)
France calls on ECB to act as eurozone growth grinds to a halt The Guardian, Larry Elliott (14/8/14)
That sinking feeling (again) The Economist (30/8/14)
Data
GDP stable in the euro area and up by 0.2% in the EU28 eurostat euroindicators (14/8/14)
Statistics Pocket Book ECB
European Economy: links to data sources Economics Network
Euro area economic and financial data ECB
Questions
- Explain how quantitative easing works.
- Why has the ECB been reluctant to introduce QE?
- What is meant by sterilisation? Why did the ECB sterilise the effects of the assets purchased under the Securities Markets Programme? Why did it cease doing this in June?
- How have events in Ukraine and political reactions to them influenced the eurozone economy?
- Should QE be ‘fast tracked’? Would there be any dangers in this?
- What is the ‘Funding for Lending’ scheme in the UK? Is the planned introduction of TLTROs similar to Funding for Lending?
The spectre of deflation haunts the eurozone economy. Inflation in the 12 months to May 2014 was 0.5%, down from 0.7% to April and well below the target of 2% (see). Price deflation can result in deflation of the whole economy. With the prospect of falling prices, many consumers put off spending, hoping to buy things later at a lower price. This delay in spending deflates aggregate demand and can result in a decline in growth or even negative growth: hardly a welcome prospect as the eurozone still struggles to recover from the long period of recession or sluggish growth that followed the 2007–8 financial crisis.
The ECB is well aware of the problem. Its President, Mario Draghi, has stated on several occasions that the central bank will do whatever it takes to ward off deflation and stimulate recovery. At its monthly meeting on 5 June, the ECB Council acted. It took the following measures (see Mario Draghi’s press conference and the press release):
• The main refinancing rate it charges banks on reverse repos (when using open-market operations) was cut from 0.25% to 0.15%.
• The rate it pays banks for depositing money in the ECB was cut from 0% to –0.1%. In other words, banks would be charged for ‘parking’ money with the ECB rather than lending it.
• It will provide targeted lending to banks (targeted longer-term refinancing operations (TLTROs)), initially of 7% of the total amount of each banks’ loans to the non-financial private sector within the eurozone. This will be provided in two equal amounts, in September and December 2014. These extra loans will be for bank lending to businesses and households (other than for house purchase). The total amount will be some €400 billion. Substantial additional lending will be made available quarterly from March 2016 to June 2016.
• It will make preparations for an asset purchase scheme. Unlike that in the UK, which involves the purchase of government bonds, this will involve the purchase of assets which involve claims on private-sector (non-financial) institutions. Depending on financing arrangements, this could amount to quantitative easing.
• It will suspend sterilising the extra liquidity that has been injected under the Securities Markets Programme (operated from May 2010 to September 2012), which involved purchasing eurozone countries’ existing bonds on the secondary market. In other words it will stop preventing the securities that have been purchased from increasing money supply. This therefore, for the first time, represents a genuine form of quantitative easing.
The question is whether the measures will be enough to stimulate the eurozone economy, prevent deflation and bring inflation back to around 2%. The measures are potentially significant, especially the prospect of quantitative easing – a policy pursued by other main central banks, such as the Fed, the Bank of England and the Bank of Japan. A lot depends on what the ECB does over the coming months.
The following articles consider the ECB’s policy. The first ones were published before the announcement and look at alternatives open to the ECB. The others look at the actual decisions and assess how successful they are likely to be.
Articles published before the announcement
Mario Draghi faces moment of truth as man with power to steady eurozone The Observer, Larry Elliott (1/6/14)
What the ECB will do in June? Draghi spells it out The Economist (26/5/14)
Draghi as Committed as a Central Banker Gets, as Economists Await ECB Stimulus Bloomberg, Alessandro Speciale and Andre Tartar (19/5/14)
ECB’s credit and credibility test BBC News, Robert Peston (2/6/14)
90 ECB decamps to debate monetary fixes Financial Times, Claire Jones (25/5/14)
Speech
Monetary policy in a prolonged period of low inflation ECB, Mario Draghi (26/5/14)
Articles published after the announcement
ECB launches €400bn scheme, seeks to force bank lending Irish Independent (5/6/14)
The ECB’s toolbox BBC News, Linda Yueh (5/6/14)
ECB’s justified action will help but is no panacea for eurozone deflationary ills The Guardian, Larry Elliott (5/6/14)
Why Negative Rates Won’t Work In The Eurozone Forbes, Frances Coppola (4/6/14)
Germany’s fear of QE is what’s stopping us from cracking open the Cava The Telegraph, Roger Bootle (8/6/14)
Data
Euro area economic and financial data ECB
Questions
- Why has the eurozone experienced falling inflation and a growing prospect of negative inflation?
- Explain how the Securities Markets Programme (SMP) worked (check it out on the ECB site). What countries’ bonds were purchased and why?
- What is meant by sterilisation? Why did the ECB sterilise the effects of the assets purchased under the SMP?
- If it is practical for the ECB to set a negative interest rate on the deposit facility for banks, would it be practical to set a negative interest rate for the main refinancing operations or the marginal lending facility? Explain.
- Why has the ECB, up to now, been unwilling to engage in quantitative easing? What has changed?
- Why may the introduction of a negative interest rate on bank deposits in the ECB have only a very small effect on bank lending?
- How much is broad money supply growing in the eurozone? Is this enough or too much? Explain.
- What else could the ECB have done to ward off deflation? Should the ECB have adopted these measures?
On my commute to work on the 6th May, I happened to listen to a programme on BBC radio 4, which provided some fascinating discussion on a variety of economic issues. Technological change is constant and unstoppable and the consequences of it are likely to be both good and bad.
In this programme some top economists, including Joseph Stiglitz offer their analysis of the impact of technology and how the future might look, by considering a range of factors, such as youth unemployment, the productivity of labour, education, pensions and inequality. The benefits of new technology can be seen as endless, but the impact on inequality and how the benefits of technology are being distributed is a concern for many people. The best introduction to the programme and its content is simply to reproduce the description provided by BBC radio 4.
The baby boom generation came of age when it was accepted knowledge that innovation and productivity would always lead to higher standards of living. The generations which followed assumed this truth would continue into the future indefinitely. With the crash of 2008 the upward mobility the middle classes assumed was their right evaporated, and it is unlikely to return.
Martin Wolf, chief economics commentator of the Financial Times, asks how the work force of the future will be changed by the advancements of technologies. How should governments respond to a jobs market which is hollowing out opportunities for traditional educated professions and how will rewards for innovation and income for labour be distributed without creating a society plagued by endemic inequality?
We will speak with optimists and pessimists on both sides of the argument to find out how the repercussions of these changes will affect the way we all live now and well into the future.
It is well worth listening to and provides some interesting insights as to what the future might look like, as the inevitable technological change continues. The link for the programme is below.
The future is not what it used to be BBC Radio 4 (6/5/14)
Questions
- What are the expected costs and benefits of technological change?
- Which factors are discussed as being the main obstacles to upwards mobility? Why have these become more prevalent in recent decades?
- Using a diagram, explain how technology can improve economic growth. To what extent is the multiplier effect important here?
- How is technology expected to affect the labour market? Use a diagram to help your explanation and make sure you consider both sides of the argument.
- What is meant by the idea that the benefits of new technology are likely to be felt in the long run?
- How important is education in creating equal opportunities?
- What is meant by secular stagnation? Is it seen as being a problem?
The growth of China over the past decade has been quite phenomenal, with figures recorded in double-digits. However, in the aftermath of the recession, growth has declined to around 7% – much higher than Western economies are used to, but significantly below the ‘norm’ for China. (Click here for a PowerPoint of the chart.)
The growth target for this year is 7.5%, but there appear to be some concerns about China’s ability to reach this figure and this has been emphasised by a recent Chinese policy.
A mini-stimulus package has been put in place, with the objective of meeting the 7.5% growth target. Government expenditure is a key component of aggregate demand and when other components of AD are lower than expected, boosting ‘G’ can be a solution. However, it’s not something that the Chinese government has had to do in recent years and the fact that this stimulus package has been put in place has brought doubts over China’s economic performance to the forefront , but has confirmed its commitment to growth. Mizuho economist, Shen Jianguang, said:
It’s very obvious that the leaders feel the need to stabilise growth…Overall, the 7.5 per cent growth target means that the government still cares a lot about economic growth.
Data suggest that growth in China is relatively weak and there are concerns that the growth target will be missed, hence the stimulus package. In the aftermath of the 2008 financial crisis, there was a large stimulus package in place in China. This latest investment by the government is in no way comparable to the size of the 2008 package, but instead will be on a smaller and more specific scale. Mark Williams of Capital Economics said:
It’s a bit of a rerun of what we saw last year – something less than a stimulus package and more of piecemeal measures to ensure they reach their growth target.
It is the construction of public housing and railways that will be the main areas of investment this time round. A sum of $120–180bn per year will be available for railway construction and $161bn for social housing, and tax breaks are being extended for small businesses.
The 2008 stimulus package saw debt increase to some 200% of GDP, which did cause growing concerns about the reliance on debt. However, this latest package will be financed through the issue of bonds, which is much more similar to how market economies finance spending.
The fact that the government has had to intervene with such a stimulus package is, however, causing growing concerns about the level of debt and the future of this fast growing economy, though the new method of financing is certainly seen as progress.
It should be noted that a decline in growth for China is not only concerning for China itself, but is also likely to have adverse consequences other countries. In the increasingly interdependent world that we live in, Western countries rely on foreign consumers purchasing their exports, and in recent years it has been Chinese consumers that have been a key component of demand. However, a decline in growth may also create some benefits – resources may not be used up as quickly and prices of raw materials and oil in particular may remain lower.
It is certainly too early for alarm bells, but the future of China’s growth is less certain than it was a decade ago. The following articles consider this issue.
China’s new mini-stimulus offers signs of worry and progress BBC News, Linda Yueh (3/4/14)
China puts railways and houses at hear of new stimulus measures The Guardian (3/4/14)
China unveils mini stimulus to to boost slowing economy The Telegraph (3/4/14)
China stimulus puts new focus on growth target Wall Street Journal, Bob Davis and Michael Arnold (3/4/14)
China embarks on ‘mini’ stimulus programme to kick-start economy Independent, Russell Lynch (3/4/14)
China takes first step to steady economic growth Reuters (2/4/14)
China unveils fresh stimulus The Autstralian (3/4/14)
China’s reformers can triumph again, if they follow the right route The Guardian, Joseph Stiglitz (2/4/14)
Questions
- How has Chinese growth reached double-digits? Which factors are responsible for such high growth?
- The BBC News article suggests that the stimulus package is cause for concerns but also shows progress. How can it do both?
- Using a diagram, illustrate how a stimulus package can boost economic growth.
- What are the advantages and disadvantages of high rates of growth for (a) China and (b) Western economies?
- Why does the method of financing growth matter?
- Railway and housing construction have been targeted to receive additional finance. Why do you think these sectors have been targeted?
As we saw in the blog post last month, Eurozone becalmed the doldrums, the eurozone economy is stagnant and there is a growing danger that it could sink into a deflationary spiral. Last month, several new measures were announced by the ECB, including a negative interest rate on money deposited in the ECB by banks in the eurozone. This month, the ECB has gone further including, for the first time, a form of quantitative easing.
