Τετάρτη, 14 Δεκεμβρίου 2011

ECB: The Quest for Purity May Lead to Obscurity

From the Business Thinker magazine 7/12/2011

 
Dr. Periklis Gogas is an invited contributor to The Business Thinker magazine. He is Assistant Professor at Democritus University of Thrace, Greece, teaching Macroeconomics, Banking and Finance. Recently, Dr. Gogas was a Visiting Scholar at the Ross School of Business, Uinversity of Michigan.

The European Central Bank, under the influence of Germany was designed with a single mandate: price stability. The function of the Fed in the U.S. is quite different as it is designed to play a significant role in preventing and fighting both recessions and inflation to avoid economic crises. It seems that the U.S. has a long memory regarding crises. The Great Depression and several other less significant in terms of impact crises since then are gone but not forgotten. This is evident in the dual mandate of the Fed that apart from the pursuit of price stability it can also intervene whenever seems necessary with an expansionary monetary policy to provide the liquidity to stir the economy away from danger.
In the European Union things are different. The design of the euro, the monetary union and the EU seems to ignore the history of crises and even recessions. The European Monetary Union’s “Stability and Growth Pact” is a great example. According to this, no member country can run a deficit and debt more than 3% and 60% of its GDP. On top of the fact that this requirement was proven to be hard to enforce, it also makes no distinction between normal economic activity and periods of recessions and even crises. This leaves European governments with no tools for implementing economic policy to avoid or dampen economic downturns as fiscal policy is limited according to the above requirements and monetary policy is in the hands of the European Central Bank where there is no mandate to fight recessions and crises.

The ECB uses a sterilized monetary policy in the recent debt crisis of the EU:  the increase in the money supply produced from government bond purchases is offset by offering to financial institutions competitive rates for time deposits. The later action drains from the market the excess money supply created from expansionary open market operations. The result of this policy is that ECB’s balance sheet is not expanding and the single mandate of price stability is achieved. This is how the ECB conducts monetary policy recently. The only problem with this is that the situation in Europe and its single currency is far from normal. Greece is virtually bankrupt, Spain, Portugal, Belgium and Ireland are very close and the problem is getting even worst as big economies such as Italy and France may face significant fiscal problems.  Conducting monetary policy as usual is like pretending that nothing is wrong. Europe lost so much precious time in handling the fiscal crisis that now even the common currency, the euro, is in danger something that seemed impossible a couple of years ago. Europe is facing a dead end: it seems that there is no way out without resorting to the solution of the Eurobond and/or an expansionary monetary policy. Germany strongly opposes the first and the ECB hides itself behind the price stability mandate and opposes the second. The reality is that the fiscal crisis will not go away and it will endanger the existence of the euro itself if the Europeans will not change the conduct of economic policy in this dire setting. This is an extreme situation and cannot be addressed by normal monetary and fiscal rules. The ECB must realize that price stability within the Eurozone can only be goal to achieve if the euro survives this crisis. It is almost an oxymoron that the financial institution that was established to issue and control the European single currency, is the one that may bring it to extinction if it stubbornly adheres to “purity” on the price stability mandate. Some credibility loss on the part of the ECB will not be the end of the world when trying to save the reason of its existence, the euro and the European Union. Or, on the other hand, Europeans could end up with a strong euro and weak economies as a result of a severe recession.
The voices of the economists, academics and politicians that ask for unsterilized intervention in the sovereign debt crisis are multiplying. The ECB must stop acting as a lender of last resort only to banking institutions and start buying some of Europe’s government debt in an effort to aid the troubled European economies in their process of structural reforms and spending cuts. Moreover, recent statistics show that even the strongest EU economies show a significant slowdown in economic activity and some may even face negative GDP growth. In situations like these an unsterilized expansionary monetary policy is unlikely to
produce inflation and contradict the bank’s legal mandate. The US is a similar example where massive government bond purchases by the Fed did not result in significant inflation. The fact that after the unsuccessful sterilization attempt last week the markets reacted positively may show that a quantitative easing (QE) and the expansion of ECB’s balance sheet may be the (only?) way forward for ECB and the EU.