The ECB meeting that took place on Thursday was an extraordinary event that achieved absolutely nothing. The market was firmly expecting cuts to interest rates, including a negative deposit rate. They got it (1). Many were also anticipating measures to ease liquidity and encourage lending, and they got that too. This was a kitchen sink meeting. Negative rates, special four year loans at fixed rates (TLTRO) that you can tap for up to 7% of your non financial lending, ECB purchases of asset backed securities, and an injection of funds via the cessation of the SMP sterilisation program. Unfortunately this is one of those times where the range of possible policies was not broad enough. In spite of everything they’ve announced, nothing will come of it.
This is because the transmission mechanism that ought to translate easier monetary policy into jobs and growth is blocked by the balance sheets of the Eurozone’s zombie banking system. The liquidity that the ECB is trying to pipe into the economy is being sponged up, often by the very regulations that the single banking supervisory authority under the auspices of the EU is foisting on banks. Banks are obliged to complete an onerous bookkeeping exercise called the ‘AQR’ (asset quality review), which will allow regulators to know exactly what kind of stuff is being held on banks balance sheets. Naturally, this level of scrutiny is making banks anxious to load up on liquidity: cash and government bonds to make their capital ratios seem reasonable when the full extent of their balance sheets are eventually uncovered. For example, Italian banks supposedly have about EUR 160bio of non performing loans. They’ll be able to tap additional ECB liquidity to cover the losses on these loans, but it’s doubtful they’ll be rushing to lend on the back of it. In other words, banks in the Eurozone will do what all financial institutions around the world have done with their extra central bank cash: hoard it, or at best, take more financial risk.
All of this is facile. The only reason we are trying to conduct macroeconomic policy using such a flawed and useless group of institutions as the banking sector is because regulation has allowed that sector to take on an absurd level of importance. Because we rely on the banks to create our money, we are in hock to them when we need to use monetary policy to coax growth from a stagnant economy. We thus get to witness the hilarious spectacle of one set of government officials forcing the banks to curtail their lending, and another shovelling money down their throats to persuade them to lend more. It’s beyond absurd, yet here we are. There are solutions to this, but they are not on the political map (full reserve banking, narrow banking etc).
A final reflection: if I were trying to construct an institutional framework for monetary policy that appeared as remote and alienated as possible from the lives of ordinary people, this is how I would do it. I spend too much of my time trying to explain the workings of central banks to people, and their bizarrely convoluted solutions grounded in arcane systems of rules make it challenging. To concerned people outside the financial system, it’s obvious that something is not right. The fact that banks reckless lending can literally make money disappear seems absurd, after all they ask, where does the money go? A good god-damn question. And one we will have to ask the ECB in the months to come when 400bio of 4 year loans via the TLTRO totally fail to stimulate any new economic activity. I look forward to it. However it won’t be ordinary folks asking the question, and that’s a shame, the need to reform our monetary system to make it work for people, and make it intelligible and honest, is urgent.
Yes the ECB is an elitist institution that sucks at its job, so hate the player. But more importantly, hate the game.