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Is Super Mario struggling to reach the next level? After two big victories – offering banks unlimited three-year loans in 2011 and then creating a bond-buying programme to keep the euro area together – Mario Draghi’s options as president of the European Central Bank have narrowed, while the economic malaise just keeps growing.
The man nicknamed Super Mario during 10 tumultuous years at the Italian Treasury has been widely praised for monetary policy actions that eased financial market tensions threatening the bloc’s existence. Yet the real economy has steadily worsened and divergences between countries are still widening.
Unemployment across the 17 eurozone countries set a fresh record on Tuesday, with country-by-country data ranging from the 26.7 per cent of Spaniards out of work in March to a rate of just 5.4 per cent in Germany. France, the number two eurozone economy, has seen joblessness rise by a percentage point over the past year to 11 per cent.
Bank borrowing costs for small companies, the backbone of many European economies, remain wildly out of touch with the interest rates set in Frankfurt by the ECB for those businesses that are located in Spain, Italy and other countries worst hit by the crisis. That means even companies that want to borrow to expand their businesses cannot, hitting employment prospects.
Meanwhile Mr Draghi, who faced strong Bundesbank opposition to the bond buying plan, which is called outright monetary transactions, has recently taken to stressing the limits of ECB action. The man who pledged to do “whatever it takes” to rescue the euro is now reminding politicians what he cannot do. “Undertaking structural reforms, budget consolidation and restoring bank balance sheet health is neither the responsibility nor the mandate of monetary policy,” he said in a speech two weeks ago in Amsterdam.
Or as Benoît Cœuré, an executive board member, put it: “The ECB does not have a magic wand”.
So what can the ECB do? There are four broad areas where the ECB has itself either hinted at action or where ECB watchers think it might act, presented in order of declining likelihood.
A quarter point interest rate cut to the 0.75 per cent refinancing rate has become more likely with a steady flow of poor business climate surveys, showing wobbly attitudes even in the eurozone’s economic heartland Germany, and deteriorating economic indicators.
The bank’s 23-person governing council meets in Bratislava on Thursday for one of its two monthly meetings per year that are not held in Frankfurt. Tuesday’s fresh record for unemployment, at 12.1 per cent across the bloc, was matched by a sharp downward lurch in inflation, to 1.2 per cent in April from 1.7 per cent in March – a three-year low.
The inflation number is critical since, formally, the ECB’s overriding mission is to keep inflation close to, but below, 2 per cent over the medium term. Signs that inflation is beginning badly to undershoot the target rob hawks of their argument that the bank risks stoking inflation by easing its policy.
If the bank cuts on Thursday, or at its next meeting in June, it is likely to leave the deposit rate at 0 per cent, many economists argue. A negative interest rate could have unforeseen consequences on bank lending behaviour. The need for a “corridor” between its refinancing, marginal lending and deposit rates is one reason why there has been little speculation about a 50 basis point cut.
But will any kind of interest rate cut actually help?
“One should be aware that the effectiveness of a rate cut is limited because the transmission mechanism is impaired in parts of the currency area,” Jörg Asmussen, another member of the six-person ECB executive board, said last week. The transmission mechanism is the process by which ECB rates translate into real world borrowing costs.
So what is a central bank to do? One unconventional policy, adopted by the US Federal Reserve, is referred to as “forward guidance” in central banking jargon.
“When short-term nominal rates are at zero or close to zero, they cannot be adjusted further down,” Mr Draghi said in the Amsterdam speech, describing how such a policy works. “The central bank may then engage in active communication reassuring markets that the future path of policy rates would not deviate from the current low level for a certain period or until certain observable conditions are verified.”
While the Fed has linked its forward guidance to unemployment, the ECB has already introduced a softer version of the policy by promising to keep its policy accommodative “as long as needed”. It could go further, but might face difficulty agreeing on which conditions would need to be met to suspend the guidance, especially since it has no formal role in controlling joblessness, unlike the Fed.
EASING COLLATERAL REQUIREMENTS
The best way of dealing with the root problem of small and medium sized companies finding it hard to borrow from banks is to look at what is causing the credit crunch. The ECB says it has been doing deep thinking on this subject, although no new policy appears imminent.
The bank could agree to accept a wider range of bundles of loans to SMEs made by banks as collateral in return for liquidity. It could also lower the haircuts it imposes on such collateral.
Both steps would help solve bank funding problems, but would not necessarily lead to more loans being extended to SMEs. Banks find themselves facing contradictory calls to both shore up their balance sheets and increase their lending.
BUYING UP BUNDLES OF SME LOANS
A more radical step would be for the ECB to directly buy up securitised SME loans itself, which would push up their prices and reduce their yields, or effective market rates. But, aside from the difficult question of exactly which loans would be chosen to be bought, this would mean taking more risk on to the ECB balance sheet.
The bank’s balance sheet has started to shrink after nearly tripling from its pre-crisis size. But any move to take on more risk would face strong and concerted opposition from the Bundesbank and possibly others, fearing that taxpayers in one country (by which the Bundesbank means Germany) would end up shouldering risks borne exclusively borne in other countries if the loans defaulted and the ECB sought fresh capital from eurozone members.