On 12th September the European Central Bank (ECB), which is responsible for monetary policy across the Eurozone, announced a new stimulus package. This included a cut in its deposit facility rate, the rate which banks earn on reserves held at the ECB, from -0.4% to -0.5% . It also included a commitment to restart its quantitative easing (QE) programme by buying €20bn worth of bonds per month .
ECB deposit facility rate
The ECB’s main objective is price stability, in particular an inflation rate ‘below, but close to’ 2% . The recent policy announcement was described as a response to the weakness of inflation in the euro area, which was at 1% in August 2019 . It also comes as growth in the Eurozone weakens, largely due to manufacturing being hit by subdued international trade. Real GDP growth is projected to be 1.1% in 2019 , as industrial production continues to fall .
Although the shift towards more accommodative monetary policy could be seen as a sensible move to revive sluggish Eurozone economies, it has not been without criticism. Jens Weidmann, President of the Bundesbank (the German central bank), said that the measures ‘overshot the mark’. The heads of the Dutch and Austrian central banks expressed similar sentiments .
One concern is that whilst European economies are seeing a growth slowdown, the situation is not bleak enough to warrant such monetary expansion. Inflation may be short of the ECB’s target, but the threat of deflation does not currently loom. By loosening monetary policy at this stage, the ECB leaves itself with reduced flexibility in the future. Another concern is that restarting the bank’s QE programme, a policy which has already seen €2.5 trillion worth of bonds purchased and which was suspended only 9 months ago , will lead to adverse side effects. Possible such effects include asset bubbles and excessive leverage (use of debt) . QE also arguably has undesirable distributional consequences, exacerbating high levels of wealth and income inequality .
Questions can likewise be asked of the decision to plunge further into the depths of negative interest rates. These are designed to punish firms for holding onto funds and to encourage them to instead lend to businesses and consumers. One issue is that banks, who incur a charge simply for holding money at the ECB, may struggle with profitability . An additional part of the policy package however helps to alleviate this- a ‘two-tier’ system for reserves has been introduced which means that part of banks excess reserves will be exempt from the negative interest rate . Pressure has also come from anguished savers who are set to find their returns further eroded. German newspaper Bild compared ECB President Mario Draghi to Count Dracula, sucking dry the accounts of the nation’s savers . QE reinforces the pinch on savers by depressing longer-term interest rates in the Eurozone economies. Although the complaints of German savers are understandable, it is ultimately the case that any policy change will benefit some groups (be it savers or lenders) at the expense of others.
It should be remembered that these are not normal times for monetary policy. Interest rates are operating around the ‘zero lower bound’ and the unconventional policy of QE, the full effects of which remain uncertain, continues to be used. ‘Emergency’ policy measures have seemingly become the new norm. In such circumstances, the scope for monetary policy to revive economic activity is inevitably limited. This is indeed recognised by Draghi, who wants to see a greater role for fiscal policy in supporting weakening euro area economies. He argued in his statement that ‘governments with fiscal space should act in an effective and timely manner’ . This comes as 13 EU member states- 7 of which are members of the Eurozone- recorded government surpluses (meaning tax revenues exceeded government spending) in 2018 . There is potential for a loosening of some of these countries’ fiscal positions to aid European growth. Germany has often come under particular scrutiny, with the country registering an ever-increasing budget surplus since 2014 (see chart). In 2018, the surplus stood at €59.2bn . With Germany on the brink of recession , now may be the time to relax the policy of fiscal prudence, perhaps through infrastructure investment. More widely the ECB wants to see countries promoting ‘a more growth-friendly composition of public finances’, and implementing structural policies (such as changes to regulatory and research and innovation policies) to support long term growth prospects .
German budget surplus as a % of GDP
Overall it is not surprising that the ECB introduced renewed stimulus in this way. Inflation falls not insignificantly short of the target of slightly below 2%, and growth is slowing. The announced policies were in fact somewhat less aggressive than markets had expected- with a €30bn per month QE policy anticipated . The ECB should however remain keenly aware of the issues associated with this recent policy shift, and the future difficulties it might face given the identified ‘downside risks’- related to ‘geopolitical factors, the rising threat of protectionism and vulnerabilities in emerging markets’ -facing the euro area economy. The bank will hope that governments will step up to the plate through fiscal policy, and it may be sensible for them to do so. Asked in his press conference whether he was sending a message to governments to do just this, Draghi simply answered ‘yes’ . Perhaps also telling was the final question asked of Draghi last Thursday. The press enquired as to any plans to use ‘helicopter money’ – money printed and handed directly to households. This was indicative of the unusual and uncertain times in which policymakers find themselves.
Second year economics student at the University of Cambridge