Draghi sets out to convince sceptics he has the right ammunition
Mario Draghi faces a daunting challenge at Thursday’s meeting of the European Central Bank, which is expected to make a fresh bid to bolster the eurozone’s lacklustre recovery. The ECB president has to convince sceptics that central bankers still have the tools to increase inflation and that measures such as increased quantitative easing and negative interest rates can bear fruit.
“QE has been working, but there is only so much central banks can do,” said Guntram Wolff, director of Bruegel, the Brussels-based think-tank, in comments that reflect mounting doubts in the eurozone and beyond about monetary authorities’ ability to grapple with the global threat of deflation. “The benefit of doing more is very low at this stage.”
Whether Mr Draghi convinces such doubters will play a big role in ensuring Thursday’s measures have an impact on the real economy. If individuals do not believe monetary policymakers can raise inflation, then they are less likely to demand higher wages. If growth is expected to remain weak for years to come, then businesses are less likely to invest in innovation or new workers and machinery.
At present, Mr Draghi and other policymakers are facing increasing questions about the limits of what monetary policy can do to fix below-par inflation — currently running at -0.2 per cent in the eurozone — and weak global demand. Although the ECB’s QE programme was launched a little more than a year ago, the bank continues to miss its inflation target of just under 2 per cent, as it has done for the past three years — a failure it shares with other central banks.
That record has created a widening gulf between partisans of more aggressive action — including distribution of central bank cash known as helicopter drops — and those who maintain that central banks are out of ammunition.
Mr Wolff suggests that further ECB efforts at stimulus risk becoming a headache for banks, which are bearing the brunt of the cost of negative interest rates. “Monetary policy is basically undermining their business model,” he said.
QE has clearly had an impact on eurozone governments, businesses and households seeking to borrow. Since central banks started to buy their governments’ debt last March, lending rates in parts of the eurozone’s crisis-hit periphery have fallen closer to levels seen in the stronger core. Bond yields for sovereigns and corporate have fallen to record lows: a German bank earlier this week issued debt at a negative yield, meaning its lenders lose money if they hold the debt to maturity.
Yet the eurozone’s economy remains fragile despite the improvement in credit conditions. With inflation turning negative again, there are big doubts that the central bank can hit its target two years from now. While unemployment has fallen, it remains in double digits and growth is still to weak to create jobs.
“Monetary policy is designed to affect the economy by influencing asset prices. There’s no doubt that what central banks have done has worked on markets,” said Salman Ahmed, strategist at Lombard Odier, an investment manager. “We should not think central banks are out of options — they can print as much money as they like. But their tools are pretty blunt and the way in which they work is pretty opaque.”
Mr Ahmed added: “Ideally, we would see more co-ordination between what they are doing and what governments are doing.”
Mr Draghi himself has always maintained that his central bank would be unable to steer the eurozone back to recovery on its own. He argues that governments should carry out root-and-branch reforms to foster stronger growth and has hinted that those with capacity to do so responsibly should spend more. But political problems in countries such as Spain and Ireland, which have both recently held inconclusive elections, have instead put still more pressure on the ECB.
The ECB president says his central bank will not “surrender” to low inflation and that there was “no reason” to think price pressures would be permanently lower than in the past.
“We now have plenty of evidence that, if we have the will to meet our objective, we have the instruments,” Mr Draghi said last month. He also argues that the ECB’s governing council was “unanimous” in holding that it had the power to hit its inflation target, although hawks on the council such as Jens Weidmann, Bundesbank chief, caution that aggressive monetary easing risks doing more harm than good.
There is as yet no sign that the ECB board members favour still more radical move such as helicopter drops.
The idea — first mooted by one of the fathers of modern central banking, Milton Friedman — is for central banks to bypass the banks and give away their banknotes to everyone. While governments have played with the idea, offering spending vouchers and tax cuts to spur growth, central banks are yet to test it.
“There’s plenty of evidence to suggest that, but no other central bank has tried out helicopter money. There is a reason for that: it’s a fiscal policy tool that needs democratic approval”, said Mr Wolff. “Giving away money is a transfer of wealth because it’s inflationary — it works like a tax on all other holders of money. That makes it highly controversial, especially in the eurozone.”