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Abheek Barua: Super Mario's not so super plans

ECB boss Mario Draghi's measures on deposit rates and asset-backed securities might not work unless the euro zone's economies revive

Abheek Barua 

Abheek Barua

The currency that hogged the headlines over the past few days was the euro. After threatening to shoot past the 1.40 mark to the US dollar just a couple of months ago, the euro finally fell below the important 1.30 level as the European Central Bank (ECB) boss, Mario Draghi, unveiled a new set of measures to give the euro zone's still-sagging economy a boost. First, he cut in the headline refinance rate (Europe's equivalent of our repo rate) from 0.15 per cent to 0.05 per cent, but that was largely "priced into" the asset markets. After all, which card-carrying central banker could look askance as deflationary pressures build up rapidly? The central bank, incidentally, revised its inflation target for the current year from 0.7 per cent to 0.6 per cent. While the policy moves might be good for growth at least in theory, it implies lower yields on European bonds and deposits. This reduces the incentive for global bond holders to hold European paper and induces a flow of capital away from Europe. The measures are also an admission of the fact that the region's economy is indeed faring badly. Both drive depreciation in the euro.

The two things that did move the markets were the cut in the deposit rate at which banks park their money with the ECB from -0.1 per cent to -0.2 per cent (no, it's not a misprint; banks have to pay to park their surpluses). Draghi apparently expects this so-called "hot potato" effect to persuade banks to lend to companies (particularly the SMEs) instead of being lazy and putting all the cash that the ECB creates back in its coffers. The second, and perhaps more radical decision, was to operationalise the purchase of asset-backed securities (ABSs), a plan tentatively announced in June, from October. This is a limited version of quantitative easing ("QE lite" as the markets have christened it) that the US did with great gusto and entails the infusion of fresh liquidity. Why isn't the ECB also buying back sovereign bonds then a la Ben Bernanke? The simple answer: Germans hate the idea and see it as a way of indulging fiscally errant sovereigns who have over-borrowed and shaky banks that hold this sovereign debt.

The billion-euro question is: will this work? The problem with the region is that its policies after the sovereign debt crisis of 2011 quickly fell prey to the dogma of "structuralism". This school of thought, championed quite predictably by the ever thrifty and super hard-working Germans, espouses almost a religious passion for austerity, fiscal discipline and reform even for economies that are in the deep throes of recession. This is in direct contrast to the Keynesian view (now passe among economists except the solitary Paul Krugman, but popular with hard-nosed politicians - a senior British politician once told me that the enthusiasm for austerity during an economic downturn was "plain daft") that believes fiscal stimulus is the only way to dig yourself out of a recession. Thus, if the Keynesians are to be heard, Europe's current mess is the result of inadequate fiscal stimulus and, in fact, the withdrawal of stimulus when it was needed the most.

Thus, Draghi's problem is a variant of the "it's the economy, stupid" syndrome. Unless the euro zone's economies revive, there are unlikely to be takers for loans even if there's lots of money floating around. The targeted longer-term refinancing operations effectively opened a spigot of cheap euros for the banks in June this year. That hasn't made much of a difference to lending. Thus, the question of how more liquidity through these ABS purchases could change the game remains.

There is yet another more analytical critique of this easy-money policy that comes from economists who attribute the slowdown in the region to balance sheet "deleveraging" by households, firms and banks. Their central point is that if this is indeed the recession driver, conventional monetary policy is unlikely to work. This deleveraging or balance sheet lightening means that individuals and companies are averse to taking new loans even if borrowing costs are close to zero.

But before getting too pessimistic about the ECB's efforts, a quick check on what the US' different QE programmes achieved is warranted. The second instalment of QE or QE2 that was introduced in the last quarter of 2010 and amounted to 600 billion US dollars' worth of bond purchases, did little to spur loan growth or revive the real economy. However, it did halt deflationary pressures and pulled up inflation expectations. So, if "price stability" is indeed the principal objective of Europe's monetary authority, monetary expansion might just do the trick. However, for it to be successful, the low-calorie QE version is unlikely to work. Draghi might just have to buy back European sovereign bonds, whether the Germans like it or not, if the plan is to succeed.

The US labour markets wobbled a little in August as the number of jobs added fell way below market expectations. Some analysts expected the dollar to shed a little weight on the back of this data release, but that was not to be. Most analysts believe that the US recovery is well-entrenched and these periodic wobbles are really aberrations rather than the harbinger of a trend. That said, these dips in labour market performance should give the doves in the US Fed the upper hand and while the withdrawal of QE3 by October is taken as a foregone conclusion, a rise in the policy rate seems some distance away.

The writer is with the ICRIER.

These views are his own

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First Published: Sun, September 14 2014. 21:48 IST