ECB Policy Is Tightening – Has Been for Some Time
The ECB dove in and hiked its policy rate by 25 basis points to 1.25%. I had the pleasure of listening to Wolfgang Munchau on Thursday, and he reiterated what I reluctantly understood: the ECB’s strict inflation target is ridiculously simple for such a complex region; but more importantly, the Governing Council is just itching to tighten.
Eurointelligence blog highlights the various interpretations of the ECB’s shift in policy: Thomas Mayer at Deutsche Bank suggests that the ECB’s normalization is appropriate, while David Beckworth and others (links at Beckworth’s site) are more sympathetic to the impact on the Periphery. They highlight that relative price fluctuations could facilitate the much-needed redistribution of capital flows (i.e., the current account); and furthermore, that ECB policy is even too tight for the core (a google translation of Kantoos Economics). Yours truly has written extensively about this – among others, here’s one, another, and another. Who’s right? Ultimately time will tell.
But I do suspect that we haven’t seen the end of this crisis. The ECB is squeezing out liquidity when more liquidity is needed. Furthermore, the core remains subject to export shocks via external demand; and there’s building evidence that global growth will slow (see this excellent post on global PMIs by Edward Hugh).
It’s ironic, too. While the ECB is currently being heralded or chastised for raising rates, monetary and financial conditions in Europe have been tight for some time, both on a relative and stand-alone basis! (read more after the jump!)
First, the ECB’s bond purchase programs, the Securities Market Programme and the Covered Bond Purchase program, amount to just 1.4% of 2010 Eurozone GDP. In stark contrast, the size of the Fed’s program broke 16% (and is rising) and the Bank of England’s purchase program remains firm at around 13% of GDP.
The asset purchase programs are emergence liquidity programs and are not normal monetary policy tools. But while the Fed and the BoE do not sterilize their flows, the ECB does. And my interpretation of ECB rhetoric and policy as of late is that they want out of the secondary-bond purchase business. For example, they’ve slowed their SMP purchases markedly in 2011 (see the ad-hoc announcements here).
Second, Eurozone financial conditions have been tightening since August 2010, while those in the US and England loosened up. Goldman Sachs constructs a financial conditions index, which is comprised of real interest rates (long and short), real exchange rates, and equity market capitalization. I love this index (subscription required), as it represents a broad measure of monetary policy pass-through.
Even though the ECB just started its rate-hiking cycle, they’ve been effectively tightening for some time.
I would say that Eurozone (as a whole) growth prospects are seriously challenged at this time, especially by comparing monetary policy to that in England and the US. We’ll see if the ECB’s able to push its target rate back to 2.5-3% through 2012 – I suspect that may be just a pipe dream, as tight liquidity and a slowing global economy drag economic growth.
The ECB’s actions imply to me that they still do not understand the following: Europe faces a banking crisis not a fiscal crisis!
Originally published at Angry Bear and reproduced here with permission.
12 Responses to “ECB Policy Is Tightening – Has Been for Some Time”
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Guest • April 11th, 2011 at 10:37 am
not sure they “dove” in anywhere…
Abraham Vela • April 11th, 2011 at 1:50 pm
Excelente article. First serious coverage of ECB monetary policy stance. However, I am also sympathetic to the peripherial economies. Certainly, sterilization of ECB Quantitative Easing and real apreciation of the Euro imply a tightening of monetary plicy. The bottom line, though, is whether real apreciation, higher interest rates and sterilized QE may endanger the recovery because of its effects on real economic activity and stressed financial institutions. Given the cross linkages among banks and sovereigns, tight monetary policy may end up achieving the opposite of the intended outcome by threatening not only the economic recovery but also financial stability. Households, corporations and financial institutions have not yet finished adjusting their balance sheets through savings, deleveraging and write-offs. Needless to add, the upturn in inflation above target is due to supply shocks, rather than strong demand conditions which remain weak. Output is below potential, unemployment is high and financial fragility prevails. If the rise in commodity prices is temporary, then they have a once-and-for-all, transitory impact in the Harmonized CPI which monetary policy cannot undo. That is why stagflation is not the observed outcome. If the international commodity price inflation is a permanent phenomena, it is still a supply shock and then inflation is imported. Monetary tightenning is not powerful enough to cope with supply shocks. In any case, the price effects of HCPI increases are already embedded in inflation expectations. The effect of a rate hike will not anchor inflation expectations is practically nil, regardless of its possible effects on non-traded goods by further weakening domestic demand. In fact, if it were not for the supply shocks, maybe the ECB would be facing a worst-case scenario: deflation plus high unemployment. The real appreciation will hamper external price-competitiveness of European exports, lessening its contribution to growth resumption when domestic absorption is already weak. ¿How to maintain price stability in a sustainable, not disruptive fashion? The challenges ahead for the ECB as a safeguard against price instability are not without risks. Monetary policy is more an art than a science. The issue then is how good an artist the ECB turns out to be. Artisis produce either masterpieces or trinkets. ¿What would it be? Let’s hope for the best and place our trust on the ECB. No one is to blame. So far, the ECB has done quite a good job. ¿hasn’t it?
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