ECB Could Be Running Out of Options

The European Central Bank has been very active recently. It has reduced its main refinancing rate to 1.0%, introduced 12-month maturity repos, a debt purchase scheme and announced that the European Investment Bank is to become counterparty in its operations. These actions are necessary but look a bit too late and not big enough. So, one has to question if the ECB used all available measures to help the distressed European economy.

At Trading Economics we think that, although the European Central Bank was too slow in implementing some monetary policy measures, its actions have been well justified and accurate. Indeed, while it’s main refinancing rate remains above the United Kingdom and United States policy rates, the deposit rate it kept at 0.25 per cent, which makes many market rates lower in the Euro Area than elsewhere. Moreover, despite resisting quantitative easing, the ECB has provided unlimited liquidity to banks at the main rate, and widened the collateral it accepts. All those procedures have been reflected in the expansion of the ECB's balance sheet, which between June 2007 and April 2009 rose by €600bn to €1,500bn ($1,997bn, £1,337bn) - equal to 16 per cent of Euro Area GDP. By comparison, the U.S. Federal Reserve balance sheet has expanded faster but, at just over 14 per cent of U.S. GDP at the end of last year. In addition, the idea of bringing the European Investment Bank to play may be very effective as the ECB money may be channeled directly to small and medium sized enterprises.

In addition, we can’t forget that the ECB monetary policy implementation is much more difficult than in other countries as the Bank is responsible for 16 countries with very different economic conditions. For example, what is good for export dependent Germany, may not be right for over-indebted Italy. Moreover, besides uncertainty over how much money should be pumped into the economy through quantitative easing 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.

Anna Fedec,
5/12/2009 4:39:49 PM