Friday, 11 March 2016

ECB's Bazooka?

This time ECB delivered what the market expected in terms of easing. By some standards ECB even over-delivered by increasing the monthly bond purchases from 60bn € to 80bn € and by increasing the Targeted Long-Term Refinancing Operations or TLTRO for short. The lead interest rate was lowered to 0.4%

After an initial bout of optimism, the stock markets had second thoughts: By delivering that much, has ECB run out of ammunition for the "bazooka". Stock markets reversed sharply. The Euro also reversed parts of its initial loss.

Reactions from the stock market are largely irrelevant in this context, since they are mostly driven by day to day sentiment anyway. I also have some trouble believing the wisdom of stock market traders when it comes to assessing the effects of monetary policy in the medium and long term. I mean, stock market traders do not usually work on that kind of time horizon, right?

ECB's initative certainly created some angry comments, mainly from Germany, where "flooding" the banks with money is seen as a bad thing. For many German observers, the problem lies mainly in the clash between a macroeconomic reality and the deeply ingrained culture of saving among ordinary Germans. Obviously, negative interest rates removes the most important incentive for saving. And that is considered a very bad thing.

Germany has had a fantastic run of economic success. It has been built on strong exports of high quality industrial products. Germany has through its success in engineering been able to be competitive beyond expectations for decades, and even lived through the 55 years after the end of WWII with a steadily appreciating currency because of strong productivity gains.

Apart from strong productivity, this success was made possible by German savers, who provided the means for the investments necessary. In Germany it is still considered a virtue for households to save.

And of course the anger at ECB is because German newspapers and a great many politicians mistake household economics for macroeconomics. There is even a name for this misunderstanding. It is called the "thrift's paradox". If we all save, we will all get poorer.

Europe does not need any more savings. We need consumption and, in particular, investments to pull us out of the quagmire. The problem is that somehow the glut of savings does not translate into finance for consumption or investment.

The problem is that the intermediary, namely the banks, are badly out of order. Too many banks in Europe are still carrying too many dud loans on the balance sheets. So they remain unwilling or unable to boost their balance sheets with new lending.

And that is the rub. The TLTRO offers cheap liquidity to banks, and is targeting banks which have grown their balance recently. But the previous LTRO programmes have not been strong in inceasing bank lending, So I do not see why it should work this time. It seems that it is not the price of central bank money that stops the banks from lending. Instead it is their bad loans.

Since 2008 I have consistently claimed that in order to get out of the crisis we need to fix the banks and to increase public spending primarily on long-term infrastructure projects.

Markets fear that ECB is running out of ammo. Markets may be right. Markets, however, forget that it is not the responsibility of central banks to push the economy. Politicians must create  fiscal policies that will resolve this crisis. And the Germans have long time ago won a complete victory in pressurising other EU countries to not do what is needed. ECB is put in an uncomfortable position because of a wrong fiscal policy.

When it comes to fixing the banks, this is not the time to be moralists. The Euro-TARP is still needed after 8 years of crisis.

Think about this one: what happens to  banks all over Europe as long as they are afraid of charging clients negative interest rates? Well, they lose money on simple deposits. Certainly, it does not provide an incentive to lend.

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