Super Mario’s last wave of magic wand
European Central Bank President Mario Draghi announced new unconventional moves in ECB monetary policy on September 4. The ECB main rate was cut from 0.15 per cent to 0.05 per cent, the deposit rate from -0.10 to -0.20 per cent and Mr Draghi also announced a private sector debt repurchase programme.
But will these measures restore lending to the economy and bring about economic growth, writes Dr Emmanuel Martin?
The problem for monetary authorities for some time now has been that the traditional levees of monetary policy are not working any more. In former times, typically an expansionary policy consisted of the central bank injecting money into the banking system so that banks would lend more to businesses and households. Consequently, investment and consumption would increase, and pull up economic growth.
Such policies do not seem to work anymore, especially since the economic crisis. Despite largely expansionary moves from the European Central Bank, money supply, in short, does not increase in the economy. The traditional ammunition of central bankers seems useless.
There are many reasons for this sluggish evolution of money supply.
One is that most money supply comes from banks and not the central bank, so the latter has less leverage on the system. Banks are crucial to financing the economy. They supply 80 per cent of the funding of non-financial firms in the eurozone. So, why are banks not ‘transmitting’ monetary policy moves, even when these are bolder?
Banks are still in a de-leveraging process after the recent crises. Their balance sheets are still not totally clean. And banks, while they certainly needed to be better regulated, have suffered somewhat from Basel III restrictive regulations reducing their ability and incentives in lending.
Banks also used new ECB liquidity to invest in sovereign bonds and equities, helping them to rebuild their profit margins.
Banks cannot just lend more to customers solely because they have more liquidity in their coffers. Customers have to be reliable and meet conditions to ensure loans can be repaid. And given today’s circumstances, many businesses simply cannot meet those loan conditions.
In France for example, company profit margins are at record lows and balance sheets are weak. Bankers have to remain prudent.
And many customers consider it is not the right time to invest given the weakness of balance sheets and the gloomy economic perspective.
Mr Draghi’s new measures aim to address some of these issues.
A new ECB programme aims to ‘free up some resources’ and ease credit. But Mr Draghi has failed to explain the size of the programme. In fact, such markets are still quite small in the eurozone, and are mostly concentrated in the core countries - when the help is needed urgently in the economies of the peripheral countries.
And what incentive do the banks have to lend more money to the economy rather than increase their profit margins by investing on financial markets with that extra liquidity, and therefore increase their market value?
The move to further lower the main interest rate will change little in the economy given that interest rates have been close to zero for a while. The move is symbolic and probably intended to send a signal that the ECB can do more.
Negative deposit rates incentivise banks not to leave their liquidity in the ECB but to lend their money, but it does not happen automatically.
The new measures still face the same old obstacles.
Structural reforms are needed in Europe, as Mario Draghi has insisted. Available money is just one aspect for businesses to generate economic growth. There is no magic monetary wand.
These measures could actually end up doing exactly what we have seen for a while - funding a financial market and a sovereign debt bubble.