Help the ECB to cross the Rubicon – Economíahoy.mx

Help the ECB to cross the Rubicon – Economíahoy.mx

Economy Hoy.mx – 8:07 – 10/01/2015

It is expected that the monetary authorities of the eurozone make history when they meet at the next meeting of European Central Bank on January 22 to set the next policy to follow. Observers anticipate that the ECB President Mario Draghi and his colleagues finally cross the Rubicon and announced the launch of a large-scale program of quantitative easing (QE for its acronym in English) -in other words, high-volume purchases bonds of the government. While the ECB has resisted QE for more than five years, even when other major central banks adopted it, the member of the Executive Board Benoît Coeuré and called it the “base option.”

At first glance, the ECB has many reasons to launch the QE. For two years, inflation never reached the target of 2 percent. In November, the annual price growth was only 0.3 percent, while the recent collapse of oil prices generate further bearish pressure in the coming months. More importantly, inflation expectations began to unpin. Forecasters and investors expect the default target in the medium term persists

Low inflation is already a serious obstacle to recovery and rebalancing the eurozone economy. The stated deflation would be an even more dangerous threat. Moreover, financial markets QE considered as likely that the vast majority of its impact on bond rates and exchange rates already taken into account. If the ECB does not meet expectations, bond and currency markets face an abrupt and disruptive adjustment of positions: interest rates increase the long term, the stock market would collapse and the exchange rate appreciate. That is not what Europe needs at a time which makes strenuous to achieve growth in a year that the United States and recorded in a single quarter efforts.

However, the hesitations are palpable. Jens Weidmann, president of the German Bundesbank, the Committee remains openly skeptical. While Weidmann does not negate the risk of deflation, argues that the consequences of recent price data may be less severe than it is believed, while the consequences of a full QE might be more serious than assumed. Several colleagues share their reserves. It is important to understand why still no agreement was reached in Frankfurt on the best possible course of action. At a time when the US data seem to validate the strategy of the Federal Reserve, why the ECB is still shown as doubtful?

Contrary to popular belief, the question has to do with the mere doctrine. True, the Bundesbank was fiercely opposed to conditional endorsement by the ECB to indebted eurozone members and supported legal challenges that confronted innovation Draghi, the scheme of direct monetary transactions (TMD). But the German authorities do not question the legitimacy of bond purchases in large scale for monetary policy, or there may be circumstances which require QE. Orthodoxy rule ECB provide support to a particular country, because this would violate the separation between monetary and fiscal policy: the authority to commit public resources to benefit a country belongs exclusively to parliaments, not the central bank. But large-scale purchases of government bonds does not raise similar concerns.

Unlike 2012, when the TMD were announced, the aim of QE is not helping governments to maintain market access . In principle, QE has nothing to do with sovereign creditworthiness. It is a monetary instrument that the central bank should depend on when your interest rate monetary policy has reached the lower limit of zero and therefore can not go lower. The level of government debt is irrelevant to deciding whether or not to use it.

However, by reducing interest rates long term purchases of government debt by the central bank can help contain the service of government debt. Thus, the QE can help solve a government that otherwise would be insolvent-a nightmare scenario for a central-bank. Japan is a good example. The Bank of Japan already has government securities for an amount equivalent to 40 percent of GDP, and is committed to make annual purchases worth 16 percent of GDP within the framework of economic revitalization agenda of Prime Minister Shinzo Abe . The sheer size of the Bank of Japan program involves already has full control of the government securities market. With annual purchases amounting to twice the deficit, it has become difficult to speak of a “market” for government debt. In fact, the Bank of Japan sets the price.

A situation of this kind may cause the central bank to become hostage to the behavior of the government. The action of the Bank of Japan is based on Abe’s commitment to restore the sustainability of public finances once deflation has been defeated and the economy has resumed a path of growth. If Abe did not fulfill its promises, the Bank of Japan would be trapped. If you stop buying government debt, it could trigger a sovereign crisis and reduce the value of their own portfolio (especially if it started selling bonds on its balance sheet). But continue shopping strengthen government control.

The confidence in government is, therefore, vital for any central bank to implement a QE. This trust does not exist in Europe. Despite an accumulation of texts and legal procedures, the EU fiscal framework lacks credibility and makes the ECB not trust that governments continue advocating sustainability once its bond purchases to protect them even more pressure market. Moreover, unlike their counterparts, the ECB does not face a single interlocutor, and none of the governments that feels responsible charge, or indeed is, the eurozone as a whole. This is a deeply unfavorable situation, which explains why the ECB, ever obsessed with the risk that governments come together to attack their independence, became the staunchest defender of the coordination of fiscal policy.

The concern, therefore, is understandable. But does not reduce the need for unconventional and bold action against deflation, and should not prevent the ECB launched the QE. The parallels with Japan highlights the need for governments to behave responsibly, individually and collectively. The elected national leaders of Europe have a role to play and should not shirk its responsibilities. The more confidence you demonstrate to the ECB, the more effective the QE.