In August 2012, the ECB president, Mario Draghi, said that the ECB would ‘do whatever it takes‘ to hold the single currency together and support the weaker economies, such as Greece, Portugal and Spain. At the same time, he announced the introduction of outright monetary purchases (OMTs), which would involve purchasing eurozone countries’ bonds in the secondary markets. There were no limits specified to such purchases, but they would be sterilised by the sale of other assets. In other words, they would not increase the eurozone money supply. But despite the fanfare when OMTs were announced, they have never been used.
Today, the eurozone economy is struggling to grow. The average annual growth rate across the eurozone is a mere 0.5%, albeit up from the negative rates up to 2013 Q3. GDP is still over 2% below the peak in 2008. Inflation is currently standing at 0.8%, well below the 2% target. The ECB’s interest rate (‘main refinancing operations rate’) is 0.25%.
The recovery is hindered by a strong euro. As the chart shows, the euro has been appreciating against the dollar. The euro exchange rate index has also been rising. This has made it harder for the eurozone countries to export.
So what can the ECB do to stimulate the eurozone economy? Other central banks, such as the Bank of England, the US Federal Reserve and the Bank of Japan have all had substantial programmes of quantitative easing. The ECB has not. Perhaps OMTs could be used without sterilisation. The problem here is that there are no eurozone bonds issued by the ECB and hence none that could be purchased, only the bonds of individual member countries. Buying bonds of weaker countries in the eurozone would be seen as favouring these countries and might create a moral hazard.
Reducing interest rates is hardly an option given that they are at virtually zero already. And expansionary fiscal policy in the weaker countries has been ruled out by having to stick to the bailout conditions for these countries, which require the pursuit of austerity policies.
One possibility would be to intervene in the foreign currency market by buying US and other countries’ bonds. This would drive down the euro and provide a stimulus to exports. This option is considered in the Jeffrey Frankel article.
Articles
Why the European Central Bank should buy American The Guardian, Jeffrey Frankel (13/3/14)
Draghi holds course in face of deflation threat Reuters, Paul Carrel and Leika Kihara (13/3/14)
ECB’s Draghi: Strong Euro Pulling Down Euro Zone Inflation Wall Street Journal, Christopher Lawton and Todd Buell (13/3/14)
Draghi Bolstering Guidance Seen as Convincing on Rates Bloomberg, Jeff Black and Andre Tartar (13/3/14)
ECB president Mario Draghi counters euro upswing Financial Times, Claire Jones (13/3/14)
Turning Japanese? Euro zone exporters must hope not Reuters, Neal Kimberley (14/3/14)
Prospect of ECB QE drives eurozone bond rally Financial Times, Laurence Mutkin (12/3/14)
Data
Statistical Data Warehouse ECB
Winter forecast 2014 – EU economy: recovery gaining ground European Commission: Economic and Financial Affairs DG
AMECO online European Commission: Economic and Financial Affairs DG
Questions
- Why is the ECB generally opposed to quantitative easing of the type used by other central banks?
- What is meant by ‘sterilisation’? Why does sterilisation prevent OMTs being classed as a form of quantitative easing?
- Would it be possible for OMTs to be used without sterilisation in such as way as to avoid a moral hazard for the highly indebted eurozone countries?
- Is the eurozone in danger of experiencing deflation?
- What are the dangers of deflation?
- Why does the ECB not cut its main refinancing rate below zero?
- If the ECB buys US bonds, what effect would this have on the euro/dollar exchange rate?
- Would purchasing US bonds affect the eurozone money supply? Explain.
- What other means are there of the ECB stimulating the eurozone economy? How effective would they be likely to be?