ECB: You can take a horse to water but….

18 September by Michael Roberts


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Last Thursday, Mario Draghi, the current head of the European Central bank, soon to be replaced by Christine Lagarde from the IMF, announced a parting gift to banks and financial markets. The ECB decided to reintroduce its bond purchasing programme in order to inject yet more billions into Europe’s banks in order to persuade them to lend onto industry and boost lagging growth.

This was the return of quantitative easing (QE) by the ECB ECB
European Central Bank
The European Central Bank is a European institution based in Frankfurt, founded in 1998, to which the countries of the Eurozone have transferred their monetary powers. Its official role is to ensure price stability by combating inflation within that Zone. Its three decision-making organs (the Executive Board, the Governing Council and the General Council) are composed of governors of the central banks of the member states and/or recognized specialists. According to its statutes, it is politically ‘independent’ but it is directly influenced by the world of finance.

https://www.ecb.europa.eu/ecb/html/index.en.html
. But this time there was to be no time limit on the E20bn monthly of ECB purchases. It was to be forever – QE to infinity! Also, the ECB would purchase not just the government bonds of debt-ridden Italy, Spain etc but also much riskier assets like corporate bonds Corporate bonds Securities issued by corporations in order to raise funds on the Money Markets. These bonds resemble government bonds but are considered to be more risky than government bonds and other guaranteed securities such as Mortgage Backed Securities, and therefore pay higher interest rates. .

Draghi also announced a new two-tier interest Interest An amount paid in remuneration of an investment or received by a lender. Interest is calculated on the amount of the capital invested or borrowed, the duration of the operation and the rate that has been set. rate system for bank cash reserves held at the central bank Central Bank The establishment which in a given State is in charge of issuing bank notes and controlling the volume of currency and credit. In France, it is the Banque de France which assumes this role under the auspices of the European Central Bank (see ECB) while in the UK it is the Bank of England.

ECB : http://www.bankofengland.co.uk/Pages/home.aspx
. These reserves have spiralled as banks took cash from ECB purchases of government bonds they held, but instead of lending that cash on in loans to the wider economy, the banks just put them back in the central bank as deposits.

The ECB decided the the interest rate was to be held at zero for excess reserves, thus making sure that banks could not lose money if they were forced to offer negative rates to their borrowers. Banks can now also raise funds at negative rates and deposit these funds at the central bank up to six times the required reserve amount and get a zero rate, thus boosting profitability.

This two-tiered idea is seen by some mainstream monetary economists as revolutionary. In effect, the ECB is boosting bank profits with its own capital at risk. Bank profits rise while the ECB buys government bonds at prices which offer negative rates and banks with large excess reserves’ can lend at a profit Profit The positive gain yielded from a company’s activity. Net profit is profit after tax. Distributable profit is the part of the net profit which can be distributed to the shareholders. to those with low reserves. But this ‘revolutionary’ policy is just about the last desperate measure of unconventional monetary policy.

The monetarists are hopeful that boosting bank profitability will lead to an expansion of lending to business and households and get the Eurozone out of its renewing depression. This assumes that the problem is the banks not being prepared to lend because it is not profitable for them. But is that the reason for low loan growth rates and investment? It’s not the supply of money or bank profitability that is the problem, but the demand for loans. Nobody wants to borrow to invest or spend even at zero or negative rates, because revenues and profits are stagnant, inflation Inflation The cumulated rise of prices as a whole (e.g. a rise in the price of petroleum, eventually leading to a rise in salaries, then to the rise of other prices, etc.). Inflation implies a fall in the value of money since, as time goes by, larger sums are required to purchase particular items. This is the reason why corporate-driven policies seek to keep inflation down. and wage growth are low and, above all, export trade has collapsed.

You can take a horse to water (and you can make it a huge lake of water) but you cannot make it drink if it is not thirsty. Even the central bankers, like Draghi, are admitting now that monetary policy has failed. And even supporters of the revolutionary new policy are not confident: “Dual rates is monetary rocket-fuel. In contrast to standard negative rates, to forward guidance, or QE, the marginal effects of these policies are increasingly powerful. I am not convinced that this specific combination of measures will suffice to generate enough demand to create an acceleration in Eurozone activity – but it will help.” Eric Lonergan.

The great new instrument to save capitalism from stagnation or a new slump is fiscal policy. “There are more and more people saying that monetary policy cannot be the only game in town, and if you don’t want more and more monetary policy the only instrument that is left is fiscal policy.” Ex-ECB board member.

Draghi called for action by European governments, particularly those with ‘fiscal space’, eg Germany to run budget deficits and spend. So far, Germany has been reluctant to do so. But if it decides to up the ante fiscally, then we can test the Keynesian solution to capitalist recessions. I’ll make a prediction: that won’t work either.



Michael Roberts

has worked in the City of London for over 30 years as an economist. He is author of several books on the world economy: The Great Recession, The Long Depression and World in Crisis. He blogs at thenextrecession.wordpress.com

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