09 September 2019

Project Syndicate: Draghi’s dangerous farewell

Ashoka Mody writes that the risks of further monetary stimulus measures by the ECB outweigh the benefits. Additional stimulus will either amount to less than anticipated or will not be sustained – yet it could still undermine the eurozone's financial system and public finances in far-reaching ways.

Mario Draghi risks deepening the eurozone’s problems in the final weeks of his eight-year term as president of the European Central Bank. He has promised that the ECB will reduce interest rates further to spur the eurozone economy. But policymakers have room for only modest rate cuts, which will do little to boost growth – and will put potentially intolerable pressure on the eurozone’s fragile banks. [...]

Christine Lagarde, who is due to succeed Draghi as ECB president on November 1, said the central bank “has a broad tool kit at its disposal and must stand ready to act.” Likewise, Olli Rehn, governor of Finland’s central bank and a member of the ECB’s Governing Council, called for “substantial and sufficient” action. Financial markets thus expect aggressive “big-bang” measures from the ECB at the council’s next meeting on September 12.

 

The risk now is that the ECB’s measures fall well short of expectations. Governing Council member Jens Weidmann, the president of Germany’s Bundesbank, says the eurozone does not need monetary stimulus. The council’s other German member, Sabine Lautenschläger, recently said that “it is much too early for a huge package.” There is no risk of deflation, she added, and hence no need for more QE. Klaas Knot, the president of the Dutch central bank, shares this view. [...]

Even if pushing interest rates deep into negative territory were technically possible, there are political limits to the scope of further QE. For starters, the ECB already holds around 25% of the bonds issued by eurozone governments. Northern eurozone members will be reluctant to buy more Italian government bonds, fearing that they would share the losses if Italy were to default. The alternative of channeling more cheap ECB credits to banks will, as before, prop up “zombie” Italian and Spanish borrowers struggling to repay their debts.

And, as Germany’s population ages, returns on savings have become a major economic and political issue – giving German policymakers another reason to oppose further reduction of interest rates.

But perhaps the strongest argument against further easing is its likely effect on the eurozone’s banks. When the ECB lowers its policy interest rates, commercial banks need to reduce the rates they charge on their loans, but cutting their deposit rates is much harder. Hence, banks’ profits shrink. And bank profitability in the eurozone is already abysmally low because the entire area is overbanked. [..]

Full article on Project Syndicate

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