It’s all getting rather interesting at the ECB. Facing a rapidly deteriorating economy and the prospect of deflation, the governing council are at odds on the best way to deal with the crisis.
Fighting out of the blue corner, the German duo of Axel Webber and Jurgen Stark argue that cutting rates further and/or embarking on quantitative easing (QE) in a US/UK style would have little positive impact. Yesterday, Webber said in a speech that he would be critical of lowering the key rate to below 1% and that “direct interventions in the capital markets should take a backseat”. Stark’s philosophy is more hawkish; in a speech he gave last month, he effectively ruled out involvement in the capital markets by stating “the health of the financial system cannot be made the ECB’s responsibility” (he didn’t offer any suggestions as to whose responsibility it is, but one assumes he is looking to individual governments). He also feels that cutting rates further could exacerbate the problem by weakening “the incentives for banks to clean up their balance sheets…and monitor their credit risk carefully”. The solution coming from these two seems to be to keep calm and carry on. They suggest continuing with the policy of offering banks unlimited loans, and Webber has also suggested lengthening the loans from the current six months to a year.
And in the Red corner, representing Greece, Cyprus, Italy and Austria we have Provopoulos, Orphanides, Smaghi and Nowotny. Provopoulos has indicated that he may support a rate lower than 1% if necessary, and would also be in favour of involvement in the capital markets. Orphanides went further in January, saying it is “dangerous” to take the view that monetary policy becomes ineffective as rates approach zero. Smaghi is a little less dovish, favouring an interest rate of zero if it’s justified, but would prefer the ECB committing to maintain a low rate of interest for a “prolonged period of time”. Nowotny agrees with the Germans to an extent as he thinks lengthening the maturities of the bank loans is the fastest option but has also recently said that “the purchase of commercial paper, corporate bonds and similar things” would be “sensible”.
The referee for the fight will be Jean-Claude Trichet. He has been non-committal as ever on “non standard measures”, although he did signal that the rate is likely to be cut to 1% at next week’s ECB meeting. None of the QE advocates have yet described how the process of purchasing government bonds (let alone corporate bonds) would work. This will be a major hurdle to intervening in capital markets, as the process will inevitably become extremely politicised. Hopefully next week both parties will add more colour to their arguments. I for one would like to have a ringside seat.
If you’re interested in watching how the fight unfolds, you can read ECB speeches as they occur here.