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5 Jun 2014
ECB's monetary arsenal has a limited range
FXStreet (London) - While the European Central Bank (ECB) today moved to cut rates, policymakers still appear committed to addressing structural fiscal problems with monetary tools.
The ECB announced a 10 basis point rate cut of its main refinancing rate, cutting to 0.15 percent, from 0.25 percent. More significantly, the Bank cut the deposit rate into negative territory for the first time – to -0.1 percent from 0 percent. The marginal lending facility rate was cut by 35 basis points from 0.75 percent to 0.4 percent.
But while the central bank has shown that it has the ability and the willingness to act, where does it go next? It can cut the deposit rate further, but past experiments with negative deposit rates - notably Denmark between July 2012 and April 2014 – have had very objections. Denmark targeted its overheating krona as the Eurozone crisis increased haven appetite, but the rate cut did not filter through to increased bank lending. The ECB’s objectives are very different – to fight disinflationary pressures and support inflation expectations.
Europe’s structural problems remain
Broadly speaking, Europe is facing two problems – cyclical and structural.
On the cyclical side of things, the global economy is still going through below-trend growth in economies where it is not in contraction and we have not yet seen a return to on-trend or above-trend growth at pre-2007 levels.
On the other hand, we have structural problems, and this is an area where you can give the ECB some grudging credit. You could argue that Mario Draghi and the ECB have done what the US and Japan in particular have failed to do and push through long-needed changes. During the European peripheral debt crises – Portugal, Greece, Ireland – the ECB and European policymakers forced through structural reforms in those countries in terms of so-called austerity, deficit reduction, shrinking of the government payroll, forcing through reforms that we might not have seen otherwise. During this time, one could argue that the ECB has eased enough to give some breathing space to allow some of this restructuring to take place, without the focus on monetary easing that the US and Japan have pursued.
By contrast, the US has done nothing to deal with its structural problems. We have seen no labour market reforms, no real fiscal constraint. Any bickering over the debt ceiling was simply a political distraction and spending continues to rise, business-stifling laws continue to be made and there is no great political momentum that is going to change that any time soon. The GOP keeps making noises but achieving nothing and the Democrats continue to try and legislate the economy out of its problems.
Time for supply-side reforms at national level
This is not an argument for a federal Europe, or for a centralisation of fiscal authority to match the Eurozone’s monetary authority. However, we have seen some structural reform in the periphery that we many not have otherwise seen. But those reforms were largely strong-armed through when the Eurozone was in crisis mode.
Labour market liberalisation
Member states of the Eurozone, particularly the core economies, have a fundamentally robust workforce. They have a high level of tertiary education, and, thanks to the Eurozone economy's slump and protracted period of high unemployment, have much lower wage expectations than US or Japanese competitors. But until individual states implement the kind of supply-side reforms that encourage inward investment and they end the culture of punitive redistributionist income and corporate tax policies, they will continue to scare off the outside investment that is required to transform human potential into economic activity and growth. And it is these changes, rather than negative deposit rates which will encourage bank lending to businesses.
The ECB announced a 10 basis point rate cut of its main refinancing rate, cutting to 0.15 percent, from 0.25 percent. More significantly, the Bank cut the deposit rate into negative territory for the first time – to -0.1 percent from 0 percent. The marginal lending facility rate was cut by 35 basis points from 0.75 percent to 0.4 percent.
But while the central bank has shown that it has the ability and the willingness to act, where does it go next? It can cut the deposit rate further, but past experiments with negative deposit rates - notably Denmark between July 2012 and April 2014 – have had very objections. Denmark targeted its overheating krona as the Eurozone crisis increased haven appetite, but the rate cut did not filter through to increased bank lending. The ECB’s objectives are very different – to fight disinflationary pressures and support inflation expectations.
Europe’s structural problems remain
Broadly speaking, Europe is facing two problems – cyclical and structural.
On the cyclical side of things, the global economy is still going through below-trend growth in economies where it is not in contraction and we have not yet seen a return to on-trend or above-trend growth at pre-2007 levels.
On the other hand, we have structural problems, and this is an area where you can give the ECB some grudging credit. You could argue that Mario Draghi and the ECB have done what the US and Japan in particular have failed to do and push through long-needed changes. During the European peripheral debt crises – Portugal, Greece, Ireland – the ECB and European policymakers forced through structural reforms in those countries in terms of so-called austerity, deficit reduction, shrinking of the government payroll, forcing through reforms that we might not have seen otherwise. During this time, one could argue that the ECB has eased enough to give some breathing space to allow some of this restructuring to take place, without the focus on monetary easing that the US and Japan have pursued.
By contrast, the US has done nothing to deal with its structural problems. We have seen no labour market reforms, no real fiscal constraint. Any bickering over the debt ceiling was simply a political distraction and spending continues to rise, business-stifling laws continue to be made and there is no great political momentum that is going to change that any time soon. The GOP keeps making noises but achieving nothing and the Democrats continue to try and legislate the economy out of its problems.
Time for supply-side reforms at national level
This is not an argument for a federal Europe, or for a centralisation of fiscal authority to match the Eurozone’s monetary authority. However, we have seen some structural reform in the periphery that we many not have otherwise seen. But those reforms were largely strong-armed through when the Eurozone was in crisis mode.
Labour market liberalisation
Member states of the Eurozone, particularly the core economies, have a fundamentally robust workforce. They have a high level of tertiary education, and, thanks to the Eurozone economy's slump and protracted period of high unemployment, have much lower wage expectations than US or Japanese competitors. But until individual states implement the kind of supply-side reforms that encourage inward investment and they end the culture of punitive redistributionist income and corporate tax policies, they will continue to scare off the outside investment that is required to transform human potential into economic activity and growth. And it is these changes, rather than negative deposit rates which will encourage bank lending to businesses.