03 March 2016

Financial Times: European Central Bank must be much bolder

This is perhaps one of the most shocking statistics about the eurozone: the last time core inflation was close to the official 2 per cent target was in May 2007, almost nine years ago. The core rate, which measures the underlying inflation trend, is telling us that the European Central Bank’s monetary policy has been off-track for a very long time. And lately, the rate has fallen again. Is there something the ECB can do when its governing council meets this Thursday?

I have three recommendations. One useful measure that would bring immediate benefits would be purchases of non-performing loans in the banking sector. It could be accompanied by policies to force cross-border bank mergers. This would detoxify and restructure the banking system in a swoop. The objective should be not to protect bank profits but to get banks to take on more risk.

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My second recommendation is about measures that should not be taken — policy gimmicks. These are decisions that get some people excited but will not lift the rate of inflation. For example, the ECB should not buy bank bonds, or indeed any other form of corporate bonds, or equity. The reason banks are not lending is not a lack of funding but the presence of too many toxic assets on their balance sheets. It would be much better to address this problem directly. [...]

My third recommendation regards future policies. The ECB should hold an open debate about policy alternatives, starting with a realisation that quantitative easing has failed. The ECB acted late, and did not do enough. QE, the injection of liquidity through large-scale purchase of bonds, might have worked if it had been implemented in 2008. When it was introduced last year, it was too late. The purchasing volumes were puny compared with similar programmes in the US, the UK and Japan; the time given for the programme too little.

Full article on Financial Times (subscription required)

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