What It Means For Global Economies & Corporates
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MORE DELEVERAGING NEEDED
However, Christian Odendahl, chief economist at the Centre for European Reform, a London-based think tank, contends that [loose] monetary policy alone could spur demand if it’s forceful enough to change inflation expectations. Up to now, Odendahl says, the ECB’s moves have been ineffective in that regard. In fact, the central bank raised interest rates both in 2008 and 2011, when it worried about a rise in prices.
That was a significant mistake, and observers are relieved that Draghi evidently believes so as well. The challenge now, however, is to convince companies and consumers that the bank will be aggressive enough to reverse the direction of prices. That conviction is critical, says Odendahl, because the actual stimulus provided by QE to the real economy will be more limited than it has been, for example, in the United States.
For one thing, European companies remain more dependent on banks for financing, so the health of the financial sector and its ability to lend is more important than if, like US companies, they relied on capital markets for finance. Yet many experts think eurozone banks remain too weak to do much lending.
“The problem with the eurozone is that there has been very little deleveraging, and it has not fixed its banks,” says Jan Dehn, director of research for Ashmore Research. In addition, ownership rates of homes and securities in the eurozone are much lower than they are in the United States or the United Kingdom, so there isn’t as much of a wealth effect to be gained from pushing up asset prices through bond purchases.
The ECB has also labored under the challenge of being the only vehicle for managing the eurozone economy because governments throughout the region are under political pressure to cut spending. In contrast, fiscal policy in the United States has been relatively loose, notwithstanding the so-called “sequester” that reduced budgets throughout the federal government, but only by a small amount.
As a result, there is more pressure on the ECB than there is on the Fed to raise inflation expectations. Odendahl is reassured somewhat by Draghi’s announcement that QE will be ongoing, much like the Fed’s third round of bond purchases, known as QE3. Until now, he says, “there was a much stronger commitment” on the part of the Fed to meet its inflation target, thanks to the US central bank’s so-called dual mandate, under which it is responsible for employment as well as price levels.
In contrast, the ECB’s mandate extends only to prices. But with deflation now a reality, the bank can move more aggressively to raise expectations. This prospect assumes, of course, that Germany and other critics don’t prevent the ECB from doing so out of extreme fear of inflation or moral hazard—the concern that failing to punish debtors will encourage them to default. Draghi must realize, says Odendahl, that the ECB “is not Germany’s central bank.”
But other observers fear that such a realization won’t matter. Should inflation expectations rise significantly, says Blyth, “Germany will start screaming, ‘Weimar, Weimar,’” and together with its allies in Finland and the Netherlands, quite possibly stay Draghi’s hand.