This Thursday, December 3, the economic world was watching Frankfurt (Germany). The European Central Bank was indeed supposed to announce new measures against the low inflation and sluggish growth in the Eurozone. It’s a fight that it has led for months. And that raises a key question: why all the measures taken launched by the monetary institution are so slow to produce effect so far?
First, we must remember that the mandate of the ECB is to stabilize price developments around the target of 2% – a rate considered synonymous with good health of the economy. But to achieve it, it has set a series of interim targets, like the revival of bank credit. To which were added during the crisis, “informal” objectives, such as the depreciation of the euro … For what results? Some of these measures have proven very effective, while others are a huge failure… Here’s why:
“QE”, negative deposit rate: tools increasingly audacious
That was a very long time ago when the main tool of the ECB was limited to determining its policy rate – that is to say the cost of money … Once this one was down near the minimum (0.05%), the institution has invented new weapons to act on the economy.
The last and most massive of them is the quantitative easing program announced in January 2015 which began two months later. It consists of purchases of public and private debt markets, initially set at 60 billion euros a month, until September 2016″. To do so, the ECB injects newly created money into the financial system in the hope that it will reach, ultimately, to households and businesses. Unfortunately, the ECB probably launched its QE too late, which limits the effectiveness. The US Federal Reserve began his program in 2008 and the Bank of England in 2009…
Another weapon is the deposit rate negative, set at – 0.10% in June 2014 and to – 0,20% in September of the same year. It is equivalent to tax banks for cash they let sleep in the safes of the ECB, and would encourage them to lend this money to businesses. But in fact, the negative deposit rate especially discourages foreign cash to settle within the monetary union. Such an influx would effectively push up the euro, precisely what Mario Draghi seeks to avoid.
The weak euro helps companies
Since March 2014, the euro, now at 1,0850 dollar has lost roughly 20% against the greenback. Although in theory it is not within its mandate, the weak euro is indeed one of the unofficial goals of the institute in Frankfurt. It forces up the price of imported goods and thus, revives inflation. At least in theory. Unfortunately for the ECB, these inflationary effects are yet offset by the sharp decline in oil prices.
Another effect is that the weak euro favours the competitiveness of European exporters who sell their products cheaper on international markets, and therefore, the activity picks up. On this point, economists believe that the strategy of the ECB is a success.
Falling interest rates benefit the states and households
This is probably the greatest achievement of the institution chaired by Draghi. In 2012, rates on 10 years’ government bonds in Greece, Portugal or Spain took off up to 37%, 15% and 7%. We all remember then Draghi saying that he will do “whatever it takes to save the euro,” by creating a first and a second public debt buyback program. The head of the Central bank has completely extinguished the debt crisis.
Spanish or Portuguese government borrowing rates have even now fallen below the 3% mark. Thanks to this, these countries were able to stabilize their public finances and resume growth.
The fight against inflation low is a failure
However, the ECB has so far failed to achieve its primary goal: to stabilize inflation around 2%. In October, inflation stood at + 0.1%. Excluding the most volatile prices such as energy, it nevertheless was + 1.1%.
Of course, the ECB is not responsible for some causes of low inflation. Weakness of wages, high unemployment rate (10.7% in the euro area), competition from low cost countries… Monetary policy might have become ineffective against low inflation. Let’s hope that this low inflation doesn’t transform into deflation, thereby engaging in a negative spiral, which will finally block the entire economy.
The Eurozone growth remains anaemic
Apart from inflation, the ECB action also aims to reinvigorate European growth. But again, results are not awesome. The monetary union’s GDP is slowing: it grew by only 0.3% in the third quarter, against 0.4% in the second and 0.5% in the first … On its own, the ECB seems unable to restore growth, States are also expected to do their share of work.
If European activity is slipping, this is also partially due to external factors such as the slowdown in emerging countries. But there are also internal factors, like the lack of ambitious reforms to boost activity, or low investment made by countries which have the power to do more, like Germany… Meanwhile, the liquidity injected by the ECB continues to fuel the rise of financial markets. At the risk of creating, ultimately, potentially devastating bubbles …