Blog Post

The ECB should be more aggressive on monetary policy

The ECB’s promise to do “whatever it takes” has stabilized the euro but its hesitant stance to fight low inflation or even deflation will undermine stability. The case for more aggressive action is strong. 

By: Date: March 3, 2014 Topic: Macroeconomic policy

The case for more aggressive action is strong. Inflation in the euro area has been steadily falling since the end of 2011 and now stands at 0.7%, well below the European Central Bank’s target of below but close to two percent. The consensus inflation forecast estimates a 1.1% rate for 2014, while market-based indicators suggest that inflation will remain below 1.4% at a five year horizon. Clearly, the euro area has been experiencing major disinflationary tendencies. The ECB’s bank stress tests and asset quality review could lead banks to further curb lending and also global risk and a euro appreciation could undermine the recovery. In combination, deflationary risks are significant while the risk of overshooting the target is minimal. Yet, debt sustainability in many European countries will look illusionary with low and falling inflation rates. Unsustainable debt would then certainly trigger the next crisis. So what could be done?

The starting point should be more aggressive standard monetary policy. The ECB was slow to cut its main rate last year. The public debate in Germany – that low rates reduce the return on German savings – should not influence the ECB’s decision-making. Monetary policy by its very nature has distributional consequences. The ECB’s legitimacy depends solely on fulfilling its mandate, which requires it to contribute to the goals of the European Union, including increased economic and social cohesion, when its price stability mandate is fulfilled. The current disinflation certainly undermines cohesion as it undermines the sustainability of periphery debt. A further reduction in the rate combined with another long-term refinancing operation would be natural and fully within the mandate.

Second, the ECB should take measures to improve directly the credit flow to corporations and households, which is still impaired in the euro-area periphery. Certainly, part of the financial fragmentation is a consequence of the unfinished business of bank balance sheet repair and should be addressed in the asset quality review, the stress test and the subsequent bank restructuring. However, monetary policy should be used to increase the credit flow and avert the risk of deflation. The experience of the last Long-term refinancing operations round (LTRO) was mixed because a lot of the additional liquidity went into the purchase of government bonds instead of credit to firms. The ECB should therefore clearly communicate that it will penalise government bonds in the asset quality review, thereby pushing lending to the real economy. A lowering of collateral standards for credit to firms would be a further instrument.

Third and most controversial would be asset purchases. The purchase of corporate bonds and loan portfolios sold by banks would be relatively uncontroversial and would improve credit conditions in the euro-area periphery. Ending the sterilization of past government bond purchases would also be uncontroversial and push liquidity into the market. More controversial would be the buying of a portfolio of government bonds. It should reduce the spreads between the euro-area periphery and the core but its overall effectiveness is questionable and it will not increase growth and inflation in the core of the euro area by much. Funding conditions for corporations in Germany and France are already very favourable and German corporations in particular rely on abundant internal finance for their investments. For the periphery, however, the Outright Monetary Transactions (OMT) programme appears more appropriate as a last recourse measure, which requires a debt-solvency assessment and conditionality.

Overall, more monetary action is clearly advisable and would not require the ECB to go beyond its mandate. In particular, the euro-area periphery would benefit from another LTRO and credit-easing measures. The euro-area core, in particular Germany, needs supply-side reforms, measures to reduce the tax burden on the middle class and increased public investment in order to re-invigorate growth and increase inflation. Monetary policy needs to do more but further government action is also needed.

 


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

Read about event More on this topic
 

Upcoming Event

May
25
14:30

How can we support and restructure firms hit by the COVID-19 crisis?

What are the vulnerabilities and risks in the enterprise sector and how prepared are countries to handle a large-scale restructuring of businesses?

Speakers: Ceyla Pazarbasioglu and Guntram B. Wolff Topic: Macroeconomic policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read about event More on this topic
 

Upcoming Event

May - Jun
31-1
10:30

MICROPROD Final Event

Final conference of the MICROPROD project

Speakers: Carlo Altomonte, Eric Bartelsman, Marta Bisztray, Italo Colantone, Maria Demertzis, Wolfhard Kaus, Javier Miranda, Steffen Müller, Verena Plümpe, Niclas Poitiers, Andrea Roventini, Gianluca Santoni, Valerie Smeets, Nicola Viegi and Markus Zimmermann Topic: Macroeconomic policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read about event
 

Past Event

Past Event

[Cancelled] Shifting taxes in order to achieve green goals

[This event is cancelled until further notice] How could shifting the tax burden from labour to pollution and resources help the EU reach its climate goals?

Speakers: Niclas Poitiers and Femke Groothuis Topic: Green economy, Macroeconomic policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: May 12, 2022
Read about event More on this topic
 

Past Event

Past Event

How are crises changing central bank doctrines?

How is monetary policy evolving in the face of recent crises? With central banks taking on new roles, how accountable are they to democratic institutions?

Speakers: Maria Demertzis, Benoît Coeuré, Pervenche Berès, Hans-Helmut Kotz and Athanasios Orphanides Topic: Macroeconomic policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: May 11, 2022
Read article Download PDF More by this author
 

Book/Special report

European governanceInclusive growth

Bruegel annual report 2021

The Bruegel annual report provides a broad overview of the organisation's work in the previous year.

By: Bruegel Topic: Banking and capital markets, Digital economy and innovation, European governance, Global economy and trade, Green economy, Inclusive growth, Macroeconomic policy Date: May 6, 2022
Read article Download PDF
 

Policy Contribution

European governance

Fiscal support and monetary vigilance: economic policy implications of the Russia-Ukraine war for the European Union

Policymakers must think coherently about the joint implications of their actions, from sanctions on Russia to subsidies and transfers to their own citizens, and avoid taking measures that contradict each other. This is what we try to do in this Policy Contribution, focusing on the macroeconomic aspects of relevance for Europe.

By: Olivier Blanchard and Jean Pisani-Ferry Topic: European governance, Macroeconomic policy Date: April 29, 2022
Read article Download PDF More on this topic
 

Working Paper

The low productivity of European firms: how can policies enhance the allocation of resources?

A summary of the most important policy lessons from research undertaken in the MICROPROD project work package 4, related to the allocation of the factors of production, with a special focus on the weak dynamism of European small and medium-sized enterprises (SMEs).

By: Grégory Claeys, Marie Le Mouel and Giovanni Sgaravatti Topic: Macroeconomic policy Date: April 25, 2022
Read article More on this topic
 

External Publication

What drives implementation of the European Union’s policy recommendations to its member countries?

Article published in the Journal of Economic Policy Reform.

By: Konstantinos Efstathiou and Guntram B. Wolff Topic: Macroeconomic policy Date: April 13, 2022
Read article Download PDF More on this topic More by this author
 

Working Paper

Measuring the intangible economy to address policy challenges

The purpose of the first work package of the MICROPROD project was to improve the firm-level data infrastructure, expand the measurement of intangible assets and enable cross-country analyses of these productivity trends.

By: Marie Le Mouel Topic: Macroeconomic policy Date: April 11, 2022
Read about event More on this topic
 

Past Event

Past Event

Macroeconomic and financial stability in changing times: conversation with Andrew Bailey

Guntram Wolff will be joined in conversation by Andrew Bailey, Governor of the Bank of England.

Speakers: Andrew Bailey and Guntram B. Wolff Topic: Macroeconomic policy Date: March 28, 2022
Read article
 

Opinion

European governance

How to reconcile increased green public investment needs with fiscal consolidation

The EU’s ambitious emissions reduction targets will require a major increase in green investments. This column considers options for increasing public green investment when major consolidations are needed after the fiscal support provided during the pandemic. The authors make the case for a green golden rule allowing green investment to be funded by deficits that would not count in the fiscal rules. Concerns about ‘greenwashing’ could be addressed through a narrow definition of green investments and strong institutional scrutiny, while countries with debt sustainability concerns could initially rely only on NGEU for their green investment.

By: Zsolt Darvas and Guntram B. Wolff Topic: European governance, Green economy, Macroeconomic policy Date: March 8, 2022
Read article More on this topic More by this author
 

Opinion

The week inflation became entrenched

The events that have unfolded since 24 February have solved one dispute: inflation is no longer temporary.

By: Maria Demertzis Topic: Macroeconomic policy Date: March 8, 2022
Load more posts