ECB Likely to Cut Rates to 1%

This week, the European Central Bank is widely expected to cut interest rates to 1.0 percent and make a decision on using the quantitative easing in its monetary policy. But are those “unconventional measures” really necessary in boosting the credit growth in the European economy?

So far, the European Central Bank has been reluctant to the use of quantitative easing. At Trading Economics we think that the main reason behind this hesitation is the strategy risk. In fact, the influence of quantitative easing on the economy is very controversial at least since it is very difficult to assess how much money supply is needed to boost credit markets and for how long those measures should be implemented. Also, we should not forget that the ability of new money to boost incomes depends on its velocity”. In fact, institutions expecting further deterioration of the economy may simply put the capital obtained from selling treasuries into deposits instead of investing them. Moreover, there is no example of a country on which quantitative easing have had a significant effect. The only economy in recent years to have tried its full-scale version for a significant period was Japan and a lot of economists argue that quantitative easing was not a factor behind the liquidity boost.

Looking further, there are some specific factors in the Euro Area itself which can question the influence of unconventional measures on the economy. Banks play a major role in distributing credit in Europe, not securities as in anglo-saxon world. What’s more, there are some limitations on buying private assets as the market is thin and poorly distributed throughout the economy. In addition, the ECB cannot use quantitative easing like United Kingdom or United States as it doesn’t have the common bonds and it would be very difficult to determine, which of its 16 governments' bonds it should buy.

Anna Fedec,
5/6/2009 5:15:27 PM