The ECB as Enabler: Doubles Down on Failed Monetary Policies

The ECB took a few surprise measures on Thursday mainly as a signal that central banks are willing to Do Something, even when sort of somethings they can do are at best unproductive. But the weak tea of lowering the benchmark rate by 10 basis points to 0.05% and announced it would be implementing a watered-down version of QE, in which it will start buying asset backed securities and covered bonds nevertheless pleased investors initially. bu the enthusiasm proved to be short lived; in the US, the modest stock market lift in the morning had gone into reverse by the close of trading. The announcement did produce one tangible positive outcome for the flagging European economy, which was to lower the value of the euro.

In fact, the ECB’s QE lite will do even less to goose the real economy than its older sibling did in the US. did in the US. First, the pool of asset-backed securities in the Eurozone is small, and some may already be in the hands of the ECB. Second, to the extent that mortgage-bond buying in the US lowered mortgage interest rates (there is considerable debate as to how much effect there really was), it did help increase consumer spending power a bit by allowing for a wave of mortgage refinancings at super-lower rates.* By contrast, outside the US, mortgages are typically floating-rate and/or restrict refinancing into lower-rate mortgages. Similarly, as Ed Harrison pointed out via e-mail, the Breugel blog last July was skeptical about the impact of having the ECB purchase backed securities. So this program is not a policy, it’s a gimmick.

But Draghi has made an art form of sleight of hand. The ECB’s OMT, for instance, amounted to pointing to a series of existing ECB powers and calling it a program, and astonishingly, investors and commentators for the most part treated it seriously.

One could go into ECB Kremlinology, for instance, that Draghi didn’t have the full support of the governing council; the Bundesbank’s Jens Weidmann was reportedly opposed. But the much bigger issue is the degree to which European policy-makers are wedded to failed policies. For instance, in a Bloomberg op-ed, Mohamed El-Erian uncritically states:

The ECB’s moves come in the context of legitimate concerns about the momentum of Europe’s already-sluggish economic recovery. They are part of a broader policy framework with four main elements:

1. Force down bond yields and interest rates, hoping that this supports jobs and growth by restoring proper credit flow throughout the monetary union.
2. If this doesn’t work fast enough, repeat with more aggressive use of bond purchases, hoping also to promote export growth by weakening the currency.
3. Pressure governments, both privately and publicly, to implement much-needed measures to promote growth and avert deflation.
4. In all this, hope that the costs and risks of experimental monetary policies don’t overwhelm their benefits.

By now, it’s evident that this “framework” is a desperate effort to avoid facing up the need for radical policy changes. Point number 1 is the economic zombie of the loanable funds fallacy. As we’ve discussed repeatedly, putting money on sale will not stimulate business expansion for most enterprises. Entrepreneurs will tell you that what determines whether they expand their activities depends on whether they see opportunity in their markets. By contrast, the type of business that benefits from putting money on sale is financial businesses, particularly ones that engage in leveraged speculation. So the cheap money fix approach only further fattens an already bloated financial sector. And that issue in and of of itself gets at point 4, the significant counterproductive effects of super cheap money.

While as we mentioned, weakening the euro would be a plus for Eurozone growth, it’s not going to be permitted to go far enough to make much of a difference. Even Japan, which was suffering with the yen long in nosebleed territory, got what amounted to a stern warning from the US when the yen reached 100 to the dollar, which at any time prior to the crisis would have been seen as an astonishingly high level.

The third element in the list, that these policies will pressure national governments, is simply barmy. Central banks engaging in largely ineffective monetary adventurism lets governments off the hook. The more the ECB and the Fed are in the medial running various stimulus placebos, the less that governments feel the need to administer the real thing, which is fiscal policy.

But as El-Erian unwittingly reminds readers, the reason that the ECB is desperately attempting to bail water out of the leaky Eurozone boat is that it is wedded to austerity, and even its new enlightened point of view of delaying “fiscal consolidation” (as in easing up on budget balancing strictures and allowing for a few years of greater deficit spending) is way too little, way too late. This is the recitation of the more enlightened Eurocrats’ prescription:

To succeed, he [Draghi] needs governments to temporarily ease fiscal consolidation and do more to improve the functioning of labor markets, foster competition, overhaul tax systems, improve infrastructure and generally enhance the business environment.

The problem with that? “Improve the functioning of labor markets”= “labor reform” = lowering wage rates. Similarly, “foster competition” generally means the reverse. It’s usually a call for deregulation, which promotes the formation of monopolies and oligopolies, which reduces competition. And you can rest assured that “overhauling tax systems” means improving collections in places with large cash economics and rich people who avoid the taxman like Greece. But that does not amount to using taxation to promote pro-growth policies, like making taxes much more progressive.

Shorter: Neoliberalism has kept Europe mired in a ditch, but the remedy for failed neoliberal policies is more of the same. But since the economic malaise hasn’t shaken the current economic and political order, preserving a bad status quo, even at a considerable cost to ordinary people, looks far more appealing than the hard and risky work of making radical changes.

While political pressures, particularly in France and Italy are rising, most commentators still think a fundamental rupture is unlikely. But as Nobel Prize winner Herb Stein said, “That which can’t continue, won’t.” Something has to give in Europe, but in the meantime, we can expect continued short-term interventions and policy legerdemain.

* But even here, the benefit was not as great as one would imagine, due to how much intermediaries rip out in fees on mortgage refis.

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  1. Lakshminarayanan

    If at all any central banker has been very successful by only talking and not doing anything it is Draghi. It is now not a question of whether any of these smoke and mirror policies will work but it is a question of how long it will continue till it breaks. Hopefully they would have run out of bullets till then. Growth till then is going to be a mirage.These pernicious CBs can continue their merry ways till it does.

  2. John

    Watching Draghi is laughable. Like his Fed counterparts he talks in a language all his own where few outsiders understand him. Kinda like Klingon. What he refuses to do is to talk plainly and in concise terms. Of course, some have grown accustomed to his coded language. In a nutshell he means: more fiscal reforms for national governments is the only remedy moving forward.

    Here in Belgium our federal government will be in place very shortly after national elections were held in May. (We could use a dose of real democracy in our electoral process. This discussion is for another blog.) Anyway, the new government has promised fiscal tightening across the board after having kicked out the socialists. And where does our new leaders get the ‘signal’ to move ahead with cuts to the social safety net? From our hawks at the Commission and at the ECB. Belgium has long been in their cross-hairs because we’ve regularly gone past those mysterious debt targets. Our guys aim to deliver some good old fashion “fiscal tightening” very soon.

    The bottomline is the EU project was poorly conceived and was not premised on a democratic foundation. It was designed so the ruling elite could usurp national governments. National governments in turn play the victim card — See, they told me to do it.

  3. The Dork of Cork

    The bankers obviously have deep political rather then strictly economic goals.

    I would argue they want to impose a American or British like banking union nightmare on European peoples no matter what the cost.
    The only difference we experience today is one of timing – the eurosystem has not matured and scaled up yet – its in the early 19th century phase of consoldation when looking at the British example.
    This sick game is about power and not money , money and its abuse is merely a mechanism.
    This second American materialist revolution imposed on us has completely devastated the previously village brain of peripheral and more civilized european peoples.

    In truth The “west” has been going backwards since the Cecils started whispering sweet nothings into Lizies ears.

    Why were many English fascinated with little island economic ecosystems of the early 20th century such as The Great Blasket somewhat divorced from the Tudor capitalistic experiment ?
    The people seemed somewhat familiar yet different.
    Many of us have come to realize that we are the abenormal types and people with distance from this demonic scarcity engine hold a certain humanity.
    Basic human scale exchange is now as dead as a dodo in Europe.
    These islands were finally changed by the Keynesian war experiment known as the Great war – the debris from various sinkings produced such a physical goods surplus that money in large quanity was needed to express the bounty in monetary terms.
    Totally changing the island dynamic within a few short years.
    The last boy who left the island in 1953 (known as the Lonelist boy in the world) was recently interviewed in a Dingle pub .
    He had become westernized as people like to call it and wanted to leave the place.
    He expressed fascination with the lights of mainland buses across the barrier of water and equated this with “progress”
    Well progress as we define it in the post enclosure period is nothing more then a illusion.
    The product of a bargain with Mephisto.

    The mainland town of Dingle is now a materialistic wreck of a gaff without enough material.
    A anti cultural hole of place with neither culture nor internal money to bind it when once it had 52 pubs in which you could have a quiet or musical pint.
    Now you cannot have either music or quietness , just Mammon without the good stuff in between.

    The Middleclass life was / is a consumer serfs life.
    A living suburban hell projected on us poor misfortunate banking conduits.

    As anbody can see now the “Eurosystem” function is not to increase wealth , but to concentrate it at all costs.
    This indeed has been capitalisms reason for being since day one as expressed by Belloc and other distributionists.
    How can anybody argue against this now – given t”he facts on the ground” (A total lack of local redundancy) that the money power has imposed on humanity.

  4. beene

    “The bottomline is the EU project was poorly conceived and was not premised on a democratic foundation. It was designed so the ruling elite could usurp national governments. National governments in turn play the victim card — See, they told me to do it.” John

    John, thanks for such a concise statement of what Central Banks and Politicians are doing and getting away with across the world.

  5. Jim Haygood

    ‘Something has to give in Europe.’

    Indeed. And the top choice on the menu is war, which nearly always vanquishes deflation whilst dilating the fiscal taps to ‘floodgate’ dimensions.

    Onward to VU Day [Victory in Ukraine]!

    1. timbers

      Yes. It’s depressing to see how many press conferences O has held regarding Syria, Ukraine, and other conflict/bombing/war opportunities vs say, the sucky job market or declining wages and bad economy.

      And opportunities for international conflict seems to animate Hillary yet when does she speak of things that matter to working people? Same could be said of O.

  6. John Yard

    A critical point was mentioned in passing, but needs to be more stressed. In 2010-2014, the US, the UK and Japan engaged in QE, which drove down the value of the dollar, pound and yen vis a vis the euro. The UK formally revalued the pound downwards. Not coincidentally, there was a relative recovery in these economies compared to the EMU. In effect, to some extent, the US, UK, and Japan have recovered by exporting deflation to the eurozone.
    If the euro can fall to under 1.20 that would equate to a relative 8% differential over the dollar/pound. This over time would be a huge boost to the Eurozone , and a corresponding hit to the UK and the US. It would be about a 4% hit to S&P500 earning yearly for a number of years . I leave to the reader the hit this would do to S&P500 levels.
    This is somewhat similar, although not as severe , as the mutual devaluations of the 1930’s. Unfortunately, in 2009-2010 there was no Bretton Woods II to plot a global strategy of recovery. Under Bernanke we have lapsed into a ‘it’s our currency, and your problem’ attitude which is undermining global recovery.
    You have to wish Draghi success in the effort to devalue the euro. After all, we did that to the dollar.

    1. jgordon

      Devaluation is like giving a terminally ill cancer patient coke. Sure he seems healthy for a bit after dosing him up, but in the end he dies anyway. The problem with every official economic system we have today is that they are all inherently unstable and destined to die. Playing gimmicky games with money based on unfalsifiable social theories isn’t going to alter that.

    2. ilya

      Stimulus as well as QE in US eliminates right on default all US corporations. Close to zero borrowing cost effects total close to zero return of US economy. Total risk of ABSes and many other bad securities are swiched to Fed. What does one should expect then?

  7. Chauncey Gardiner

    Thank you for this excellent post. However, in glancing at the charts of balance sheet growth at the world’s major central banks, I think it is useful to note which one of them has been an outlier since 2012:


    I further believe that in terms of timing it is no coincidence that former Goldman Sachs senior manager Mario Draghi’s ECB is re-embracing balance sheet expansion as the Fed “tapers”. I also question what is being lost in this ECB-Fed shuffle?… i.e.,

    BIS central guidance and control?
    Peoples Bank of China’s policy control?
    Other entities who play a meaningful role, such as the IMF?

    So the Germans want hard money, have embraced Austerity, and have an aversion to domestic fiscal spending. They are far from the only ones. In fact, this seems to be the universal policy choice among those presently in control of all supranational monetary institutions, all major central banks, all Western sovereign governments, and the global financial markets. Aside from lip service, they all continue to embrace policies designed to concentrate wealth and political power in the hands of a few, and to ignore domestic non-military fiscal spending policy initiatives.


  8. MarcoPolo

    I ‘m writing from Barcelona where wages are too low, taxes too high, control too onerous and prices too sticky to create any demand that would allow this economy to drive itself out of this depression.   The euro would have to fall off a wall to make up that difference.  (Which may happen, Mr. Dumpty.)  What I see as being different is a broader, street level understanding of how the euro itself is responsible.   Draghi’s new talking points serve only to indicate that the politics have shifted a few basis points away from the Germans and toward the French.  Nothing really changes – yet.  When change does come you aren’t going to see it coming from Draghi


    1. Yves Smith Post author

      Wolfgang Munchau pretty much made your point in 2009 or 2010. He said the euro would need to fall to the 60 to 80 v. the dollar range to pull Europe out of the ditch. He made more dire predictions as to what would happen if not. The “if not” is taking a long time to happen but it is hard to see how you can reduce so many people’s standard of living so quickly (and that anodyne expression way understates the degree of stress/distress) and not have serious consequences.

  9. Moneta

    By now, it’s evident that this “framework” is a desperate effort to avoid facing up the need for radical policy changes
    I bought a house from a downsizer. When he took out the pool, he left the deck which was made up of three levels and built a garden all around it. The yard became an overgrown garden with little paths here and there. I took quite a bit of work to get rid of that deck. And the whole time I was working, I could not help thinking about why he probably did not want to get rid of a rotting deck:

    1: Sunk cost
    2. Too much work
    3. Failure to see outside the box
    4. Sentimental attachment to that deck

    Those are the same reasons tour leaders are doubling down. Nothing will change until there is some changing of the guard.

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