17 November 2013

Wolfgang Münchau: Why Europe needs to try unconventional policy

There are three reasons why he should now look beyond the conventional. The first is, of course, the economic outlook, and the associated downside risk on inflation...

The second reason is a lack of further policy tools after the next rate cut... The central bank could cut its main rate one more time and impose a small negative deposit rate. At that point, the ECB will have run out of policies. That would be an uncomfortable position.

The third set of reasons relates to Mr Draghi’s lender-of-last-resort promise – the outright monetary transactions he launched last year. The OMT has no doubt calmed down markets over the past year, but it is not a monetary policy instrument. It is an insurance policy. Its purpose is to reassure investors by reducing the likelihood of a country’s being forced from the eurozone. But it is still only a backstop. Quantitative easing, by contrast, is a monetary policy instrument. Its purpose would not be to bail out countries but to reduce medium to long-term interest rates in specific sectors of the economy.

Even though QE and OMT differ, they are both asset purchase programmes in the end. If the OMT lost credibility you would need another asset purchase programme to take its place. That could happen if, for example, the German constitutional court were to rule against the OMT in one of its forthcoming judgements. The court is currently considering whether the OMT violates the German constitution. In a hearing in June, the chief justice left no doubt that he has fundamental problems with the programme. Even if the verdict is nuanced – as verdicts by this court usually are – any doubts about the OMT’s legality or practicality might upset investors. At that point, the ECB would be well advised to have a plan B in place. QE could meet that requirement. 

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