Wednesday, 18 July 2018

Things the ECB supposedly won't do, and Europe may never

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  • James Saft - June 2014

It tells you something important when the European Central Bank chooses to emphasize the role of fiscal spending and structural reform in any economic recovery.

It tells you even more when the ECB sees the need to play down the possibility of a helicopter drop of money directly to the public.

While both options deserve consideration, the ECB’s need to advocate, however mildly, for the first and to play down, however circumspectly, the second, is remarkable.

What happens now we can’t be sure, but it seems clear that the central bank has less than full confidence in its more traditional array of tools.

“The minutes of the ECB’s monetary policy meeting on March 10th may reinforce concerns that the Governing Council is starting to run out of ammunition,” Jonathan Loynes, economist of Capital Economics in London, wrote in a note to clients.

Released on Thursday, the minutes from last month’s monetary policy meeting, at which the ECB both cut deposit rates further into negative territory and expanded asset purchases, showed internal divisions over both tactics. There were particular concerns raised over the impact of negative interest rates on bank business models. Those concerns aside, the minutes indicated that rates could be taken lower, and officials have underlined their willingness to use their balance sheet.

“Accordingly, we still think that a further extension of the asset purchase programme is likely at some point and would not entirely rule out more drastic measures such as some form of ‘helicopter drop’,” Loynes wrote.

Two ECB officials stepped forward on Thursday to damp down speculation over a helicopter drop, a phrase originated by the economist Milton Friedman, who theorized that a central bank confronted with refractory deflation could simply rain down money from the sky.

ECB Chief Economist Peter Praet said such direct payments were “not on the table, it’s not even discussed” while Vice President Vítor Constâncio added flatly that helicopter tactics were “not on the table in any way, shape or form.” So, you’re saying it’s not on the table, then?

That the ECB isn’t actively considering direct transfers may be true, but ECB chief Mario Draghi’s characterization of them last month as “very interesting” indicates that what once was an academic debate, and a fringe one at that, now looks less like a bad movie script and more like an option.

Consider that, even with stimulus that the ECB credits as having raised inflation about a half a percentage point above where it would otherwise have been, prices are falling by 0.1% annually in the eurozone as of March. That’s an improvement on February’s negative inflation rate of 0.2%.

Hard-to-reach spots

Direct transfers are interesting because they reach where interest-rate-based monetary policy and asset purchases seem to be having difficulty. More of the money would be spent and less of it find its way into speculative bubbles driving up the prices of assets. At the same time the “free” money neither gums up the banking system nor imperils its ability to make profits, as negative interest rates do.

While the political and practical issues of a helicopter drop are thorny, they may be easy in comparison to the ECB’s fond wish of more fiscal stimulus and structural reform.

While making labor and product markets more efficient is a long-term project, it is always twinned by the ECB with calls for spending money to stimulate the economy.

“There was a need for both structural reforms and fiscal policy to also play their part,” according to the minutes.

“Members highlighted the need to comply with the rules of the Stability and Growth Pact, while at the same time stressing that existing elements of flexibility should be used. A more growth-friendly composition of fiscal policies could support the economic recovery, as could the use of fiscal space, where appropriate.”

This is only the latest such bleat. Governing council member Ignazio Visco has said the ECB could “buy time” but its policies were, in themselves, not up to the task of creating ongoing growth without a fiscal amplifier.

Both of these pleas, for reform and cash, are fair, if not likely to be met with results. The eurozone has a fiscal- and tax-shaped donut hole at its center which makes it almost inevitable that too much emphasis is placed on monetary policy, which after all can be handled by one group meeting once a month or so in one room.

Try doing that with labor market reforms, much less anything meaningful on the fiscal side. Euro zone problems are long-term issues and deflation is a self-reinforcing phenomenon.

Hold your breath and you can almost hear the whirring of blades.

(James Saft is a Reuters columnist. The opinions expressed are his own. At the time of publication he did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at

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