The Euro Area’s Experience with Unconventional Monetary Policy
Cristiano Boaventura Duarte, André de Melo Modenesi
Cristiano Boaventura Duarte , PhD Student Federal University of Rio de Janeiro and Central Bank of Brazil. email: cristianobduarte@gmail.com
André de Melo Modenesi .Associate Professor at Federal University of Rio de Janeiro (UFRJ) and researcher of the Scientific and Technological Development Council (CNPq). email: amodenesi@gmail.com
Please cite the paper as:
Cristiano Boaventura Duarte, André de Melo Modenesi, (2015), The Euro Area’s Experience with Unconventional Monetary Policy, World Economics Association (WEA) Conferences, No. 2 2015, The European Crisis, 1st October to 1st December, 2015
This paper has been included in the publication
“The European Crisis”
Abstract
This paper discusses the role of monetary policies implemented by the European Central Bank (ECB) after the 2008 financial crisis, with a special focus on unconventional measures, analyzing to what extent they influenced Euro area’s macroeconomic performance in the period. After the 2008 shock in the USA, several conventional and unconventional monetary actions were implemented by the ECB. Although the initial measures prevented a massive failure of banks, they didn’t avoid the escalation of the situation into a serious sovereign and banking crisis, which had roots deeply inserted in the Euro area itself. Some programs like the SMP received strong criticism, but other measures like the OMT avoided the more acute risks of contagion through the Euro area. Nonetheless, with persistent economic weakness and risk of deflation, the ECB extended its stimulus programs in September 2014 (TLTRO, CBPP3, ABSPP) and in March 2015, with a broad unsterilized public sector purchase program (PSPP). As they corrected some of the problems from previous programs, and conveyed a strong commitment to fight deflation, those programs initially lead to positive effects on several macroeconomic indicators (sovereign yields, euro exchange rate, credit, output, inflation), although with some volatility on yields and the euro later due to intra and extra-Euro area factors. Considering that medium and long-term expectations still remain in low levels, the ECB intends to continue the program until it gets to its inflation objective of below but close to 2%, and may even review the program if it happens an unwarranted tightening of financial conditions. Nevertheless, serious problems remain for households (high levels of indebtedness and unemployment), enterprises (challenges for investment, financial volatility) and governments (fiscal, political and institutional constraints). It is argued that the path for a sustained growth recovery in the Euro area not only goes through unconventional monetary policies. They should also be complemented by a coordinated fiscal policy, more flexible (and countercyclical) in periods of economic downturns, coupled with adequate institutional reforms that together foster credit markets, encourage private and public investments in the long term and reduce regional asymmetries. Additionally, it is believed that a more robust and integrated financial supervisory framework (not only on banking but also on capital, insurance and pension markets) would contribute to reduce negative spillovers from financial volatility episodes, break the sovereign-bank “doom loop” and bring more financial stability to the zone.
As far I could understand European unconventional monetary policy did not fix and rescue the monetary policy traditionally functioning; crisis is still there. One possible reason for sovereign debt crises is that public debts normally follow explosive trends, as demonstrated in the paper Public Debt Is Economic Nonsense, presented at the previous WEA Conference Ideas towards a new international financial architecture? So, if problems remain why to insist on monetary policies alternatives?
You also propose a “coordinated” fiscal policy as a complement to the monetary policy in order to (re)create sustained growth, as if previous growth were sustained. Fiscal policy seems to be a consensus in this context; it has been called to fix messes created by monetary policy here and there and after doing its job it must go back to textbooks and stay there until the next call. Before suggesting fiscal policy one must find how to countervail, without touching democracy, the restriction given by the uber alles central bank’s target of price stability (to preserve the central bankers’ financial capital value).
The paper Economic Policy and Political Power in European Crises in this Conference brings a demonstration that fiscal policy does not cause inflation as the mainstream monetary repeatedly says without any evidence. So, why not fiscal policy without monetary policy? I would appreciate it very much if you could comment on my paper.
We have common grounds agreeing in the importance of fiscal policies. But fiscal policies do not serve only as “temporary remedies” to “fix messes of monetary policies”. Actually, they have a permanent role in the economy, with their main functions: i) resource allocation (efficient provision of public goods and services); ii) income redistribution (ensure equitable distribution of income); iii) macroeconomic stabilization (promotion of economic growth, lower unemployment rate and price stability). So their role is not just temporary, to correct eventual government failures. In fact, when properly done they have a permanent seat in the economy and the society, promoting more growth, social fairness, and correcting market failures (or operating where the markets do not have own incentives).
In addition, monetary policies are not just supposed to “serve to the interests of the financial industry and politicians”. Beyond the traditional targets of ensuring price stability, or in some places the level of employment/income, many central banks (mainly after the 2008 crisis) have also incorporated in their objectives the maintenance of financial stability and the promotion of financial inclusion. In order to do so, they have widened their own instruments or called into action other institutions, such as financial stability authorities and development banks. Regarding the European case, although the region is still far from a sustained recovery after the 2008 crisis, it would be surely worse without the conventional and unconventional actions just after the crisis. The provision of targeted liquidity, swap lines, etc. surely avoided a financial meltdown in the region. Following monetary measures had mixed results, but many specialists recognize that unconventional measures in other places were most effective through their signaling channel (what also seems to be true for the Euro area, who managed to avoid more acute effects in 2012 after Draghi´s “Whatever it Takes Speech” and the OMT). This points to the increasing importance of central bank´s communication strategy and transparency in objectives nowadays. Ultimately, evidences show that monetary policies matter, but cannot “save the world” alone. They must be properly coordinated with fiscal policies, financial stability and inclusion initiatives, as well as a proper legal and institutional framework, in order to reach better economic and social results.
According to this report, at the top of this enervating history, the ECB bank decided not to enlarge its balance to 1 Eur trillion, as for leaded by fear of deflation.( dec 2014). After 14 years of struggling against the inflation the ECB saw in -0,2 % deflation a reason to stop the liquidities enlargement program. This reason seems to me a fallacy. Several times of inspection of the “adequate” monetary artcls in Treaty and Statute brought the conclusion that the financing of trading in the new instruments was badly covered. Initially those artices suggested the possibilty of furnishing the enlargement of ECB capital by means of an article permitting furnishment by means of printing banknotes, but later on this article dissapeared in a mysterious way. Several years later a new art. appeared concerning electronic multiplication of banknotes. This opened the heaven, but it was followed by a restricting protocol, leaving the buying of a new instrument (SWAP) to the existing means of the banks. Those kind of measures and contradicting followups leave the participants in an unsure field of hesitation about the furnishment of the last ressort and temper the market intensity, still abandoning the possiblity of enlargement of the ECB balance on a secure juridical monetary foundation.
Pasbaxo,
Thank you for your comment. I agree with you that the limited role of “lender of last resort” provided by the ECB is an issue that should be improved in order to ensure the financial stability in the Euro area, as I pointed out in the text. Indeed, authors like De Grauwe (2013) and Arestis (2015) consider the OMT introduced in September 2012 a “lender of last resort” role for the ECB, by establishing the possibility of buying sovereign bonds in the secondary markets in order to stabilize countries’ yields. The OMT has actually avoided the most acute risks of financial collapse of the Euro area. However, the OMT has several caveats: I)The program’s complete rules were never published. One knows that the program does not allow bond purchases in primary markets, excludes countries that are under financial aid programs, and requires several previous “conditionalities”, but their details are not clear. ii) The program faced fierce opposition and legal challenges (dismissed by the ECJ, but still waiting a final ruling from the German Constitutional Court), and ended up never being activated. In addition, the ECB is not backed by an “Euro area” Treasury, like the FED or the BOE. Therefore, our point of view is that the “lender of last resort” role introduced by the ECB is still limited, and does not enjoy the same powers as other central banks.
Finally, I will just make an explanation of a point you raised in your comment. The ECB “implicit objective” to raise the balance sheet in € 1 trillion ( to € 3 trillion, level observed in early 2012) did not come with deflation in December 2014. It was announced before, in September 2014, together with the new programs (TLTRO,CBPP3, ABSPP). Although low inflation (+0.3%) was a concern then, those programs aimed primarily to restore the transmission of the monetary policy and support the provision of credit to the real economy. It was just in January 2015 the ECB realized it would not be able to fulfill its € 1 trillion balance sheet expansion objective only with the current programs and announced further stimulus, such as the PSPP. This time, the main objective of the program stated by the ECB would be to restore inflation/ inflation expectations towards the medium-term objective of below but close 2% YoY.