There is a tremendous amount of analysing, posting, chattering, and gossiping about what the decisions will be that president Draghi will make public at the press conference following the governing council meeting on June 5. So much attention is not unheard of, but it is not normal, either. One must try and understand what the fuss is about.
Let us start with the fact that at the last press conference held on May 8 Mario Draghi announced something very momentous, that is, that “..the Governing Council is unanimous in its commitment to using also unconventional instruments…”. This no small change. True it is that Mario Draghi is not new to addressing the press with momentous sentences delivered with an humble tone of voice and expression: who does not remember that famous “..whatever it takes…”?
Now, given that “unconventional instruments” are required, one would be prone to imagine that ‘extraordinary problems’ are afflicting Europe (or at least the EMU). My first reaction to that is: so, what is new? Has it ever been good, or even half-decent, since that August 2007, when the credit crunch was started courtesy of banks and financial intermediaries? Or since that terrible 2009, when the governments of countries belonging to the EMU made pretend that there was a recession because of excessive government debts –and not because of a credit crunch? Of course not. But the realization by the ECB that the situation requires “extraordinary means” is to be welcomed nonetheless.
The extraordinary problems
This is easy: a 13% average unemployment rate (and an even scarier rate for the young); shrinking household incomes and expenditures; falling household wealth; a credit crunch as hard today as it was six years ago, despite the unprecedented amounts of liquidity thrown at banks and financial intermediaries at very low cost over the years; falling international competitiveness; a shrinking industrial base; an inflation rate that is less than a third of the ECB mandatory target, with the ugly head of deflation in plain sight (on May 31 the governor of the Bank of Italy will supply us with up-to-date evidence on these issues). One could go on, of course, but this list is already terrifying enough. Thus, agreed: extraordinary problems, extraordinary means.
The unconventional instruments
Let us take a look at what these “unconventional instruments” might be. If newspapers and banks’ research departments are worth anything at all, we can resort to them to see what they are imagining these instruments might be. Here is a list on which there seem to be some sort of consensus. I cannot quote sources, but the careful reader will find pretty much the same numbers in most newspapers.
- The main refinancing rate, standing now at 0,25%, may be cut to 0,15% (or even 0,10%, according to some analysts);
- The above would imply a similar-size drop in rate on excess reserves, which would go from 0 to -0,10%, and on the marginal refinancing rate, which would drop from 0,75% to 0,65%;
- The above two policy measures are taken for granted by many commentators. The next would be either to announce a purchasing program to buy ABS comprised of small and medium-enterprise loans; or, alternatively a version of a Long Term Refinancing Operation, that is, a remake of that (in)famous injection of € 1 Tln of liquidity into the banking system for three years at the rate of 1%, liquidity used by banks in part to purchase (own) government debt and in a lesser proportion parked with the ECB as excess reserves. One can easily imagine that with a negative rate on excess reserves banks will employ all their share of liquidity to purchase (own) governments bonds, this time! But can anyone imagine them supplying credit to the real side of the economy?
- A final policy measure is under consideration, we are told: Quantitative easing. But, we are reassured, this is “a big bazooka” that will not be shot for some time yet.
Finito. Is anybody finding even the remotest correlation between the gravity of the situation and the policy moves being considered? Not me. You see, all this monetary policy debate is, I am claiming, about nothing. Why?
As the story used to go, central banks can do a lot of good to the real economy by cutting policy interest rate, for instance the main refinancing rate, a move that will ‘trickle down’ to all sorts of market rates and thus irrorate the dry plains of investment and consumer spending. Now, I have always been a bit skeptical of that story, but now I find it outright ridiculous.
Nowadays central banks, including the ECB, are stuck against ‘the zero lower bound’: that is, nominal interest rates are at, or near, zero. No more conventional expanding the way briefly summarized just above. So, what can they do? Be unconventional: that is, the points above. And keep pretending to believe that negative, extremely small interest rates on commercial banks excess reserves deposits will force banks to resume lending to households and businesses just because otherwise they will lose money lending to the BCE!!
Now, the reason why all this will not work on the real economy is the same that it has been in the seven years since the beginning of the credit crunch and, consequently, of the great monetary expansions (conventional, to be sure, at least in the EMU): interest rates are not the only, and in this conditions certainly not the major, determinant of demand for credit by households and firms. Such demand is driven essentially by expectations. Firms spend on investment goods to expand their production capacity, which requires two conditions to be fulfilled for the investment to take place: that there is not a very large unutilized capacity to begin with, and that expectations of future sales are positive, if not bright.
Well, as it turns out and Eurostat is documenting for the benefit of us all and the Governing Council as well, neither of those two conditions is fulfilled.
Having said that, two questions remain: why does the ECB do it, then? And, what would I do, instead?
The answer to the first question is simple: ineffectiveness of monetary policies relative to the real side of the economy does not imply ineffectiveness relative to the financial side! Stock markets are at the peak valuations in years, and compensations and bonuses for all sorts of financial firms’ CEO, CIO and CFO are sky high. See the hint?
And, what would I do? Easy, the same thing I am recommending since 2008: stimulate the economy through additional government spending. In those countries where that can only be done under the constraint of balanced budgets, finance the additional expenditures through higher marginal tax rates on high incomes and substantial wealth. Spend on competitiveness-enhancing measures, such as a decent ratio of the young earning a higher-education degree. That is bound to restore the ‘inflation target’ and take us out on a growth path, in addition to restore positive expectations in households and firms.
But, let us wait and see. Much ado for nothing, says I. Save on financial markets, of course, which will be kept happy for an extended period. (Or, as poet sings, “…up on banker’s hill, the party’s going strong. Down here below we’re shackled and drawn…”)