ECB Cuts Rates From 'Almost Nothing' to 'Next-to-Nothing'
Yesterday the ECB 'surprised' many market observers by making a major move in its interest rate policy at its meeting in Bratislava. This is unusual as the ECB is known for preferring to announce major decisions in Frankfurt, where its headquarters are situated.
Anyway, apparently the governing council thought the current economic situation required 'swift action' and thus decided to cut its repo rate from 75 to 50 basis points, the marginal lending facility's rate from 150 to 100 basis points, while leaving the deposit rate at zero. Concurrently Draghi announced in his press conference that the various special liquidity provisions offered by the ECB to banks (LTROs, ELA and so forth) will be subject to full allotment until the summer of 2014 at a minimum, and thereafter for 'as long as needed'.
It also became known that German governing board member Jörg Asmussen apparently voted against the rate cut (but curiously, BuBa president Jens Weidmann is said to have voted for it). Asmussen argued that it could not possibly make a difference whether the ECB charged 50 or 75 basis points – especially considering that banks with access to interbank markets can refinance themselves at an EONIA rate of about 5 to 7 basis points these days, i.e. basically 'nothing'. Asmussen is of course correct. At best the rate cut may have a psychological effect and even that is highly questionable. It certainly won't magically lift the euro area out of recession. Note in this context that euro-area wide unemployment has recently hit a new record high of 12.1%.
Given that administered rates are already extremely low, the danger of spurring more capital malinvestment is actually quite high, especially in places like Germany, where the economy is doing comparatively well. Hence Amsussen's dissent.
Draghi's Press Conference
Much was made of an off-hand remark by ECB chief Mario Draghi at the press conference with respect to the ECB's deposit rate. The deposit rate is the rate paid by the ECB on excess reserved deposited with it by commercial banks. When this rate was cut to zero last year, over half of the excess reserves were immediately moved out of the ECB's deposit facility and into the euro-system's current account facility, where they continue to linger (less LTRO repayments that have been effected in the meantime). One of the journalists asked Draghi whether he would be open to introducing a penalty rate on excess reserves, this is to say a 'negative interest rate'. Draghi mumbled something about his 'mind being open' about the possibility, after previously expressing caution regarding possible unintended consequences.
Such negative interests on deposit facilities were previously implemented in Denmark and Sweden, and in the former there were indeed 'unintended consequences' if memory serves (mainly in terms of creating interest expenses of 500 m. Danish crowns for the banks per year, something they could ill afford). On the other hand, given that the central bank's deposit facility is by far the safest type of demand deposit in existence – the central bank can never 'run out' of money after all – it should actually charge a fee for its use.
It is actually wrong to call this fee a 'negative interest rate'. Negative interest rates are an impossibility, as they would violate the law of time preference. Future goods cannot be worth more than present goods. If we knew for certain that the world will go under in a week's time (say via an asteroid strike), the discount of future goods versus present goods may well approach infinity, but the opposite can never happen.
Anyway, in our view the possibility of the ECB charging a penalty rate on excess reserves in its deposit facility isn't worth the attention it apparently received – simply because banks will then move the funds into the current account facility. We doubt it will create an incentive for them to increase their lending, and evidently the interbank market is already drowning in liquidity – as indicated by current EONIA rates of 5 to 7 basis points.
Draghi noted that the central bank stands 'ready to do more if needed' and also indicated that while there was a broad consensus regarding the 25 basis points cut in the repo rate, there were apparently also a few board members who apparently argued in favor of a bigger cut (this can only be inferred from his remarks, he didn't say so explicitly). He also expressed a desire for the creation of a larger ABS market in Europe, as the ECB is slowly but surely running out of assets to buy. Since the ECB is forbidden from providing monetary financing to governments, the choice of assets it can buy in order to implement something akin to 'quantitative easing' is rather limited. We are fairly sure though that the central bank will be able to overcome any impediments to more money printing when occasion seems to demand it.
Aside from these technicalities, there was one remark Draghi made that struck us as quite interesting. He was repeatedly asked about the 'austerity versus growth' debate that has recently flared up again after spreadsheet errors were discovered in the famous Reinhart-Rogoff paper on the connection between public debt and economic growth (we have discussed this topic previously). One question was: “Is the ECB the last defender of the austerity policy left standing?” This question was motivated by Draghi's introductory remarks, which included an admonition to euro area governments to continue with fiscal consolidation.
On this Draghi noted that many governments made their decisions regarding austerity under duress at a time when market pressures were intense. As a result, they chose the 'easy way' by mainly raising taxes. According to Draghi, this is the wrong way to go about austerity. Governments should rather look toward cutting spending and implementing reforms he said. Now that the immediate pressure is gone, they should actually think about cutting taxes in concert with cutting spending.
In spite of our general distaste of central banks, we have to agree with Draghi on all of this. This is precisely how austerity should be implemented – by cutting spending, cutting taxes and implementing reforms in the form of a liberalization of labor markets and the rescission of the jungle of stifling regulations that represents such a huge obstacle to business in Europe. Whether Draghi's views on this will carry water with the rapacious governments of Europe remains to be seen. We have grave doubts about that, but it is nevertheless refreshing that he is advocating a different approach.
One Size Fits All?
Draghi was forced to admit that the business cycle in various euro area member nations is not aligned. As a result, the ECB is facing an even more impossible task than other central banks when deciding on where interest rates should be fixed. He could not provide a satisfactory answer to how this problem could possibly be resolved, apart from noting that the recession is now spreading to the euro area's 'core' as well, which in his opinion makes the ECB's current loose monetary policy appropriate for all member nations.
However, the danger of an unsustainable asset price boom forming in places like Germany seems to us to be very real. Even chancellor Merkel seems to have recognized this, as she recently noted that for Germany higher interest rates would likely be appropriate at this stage. The German banking association recently also issued a warning that the ECB's loose monetary policy might cause a bubble in Germany.
We actually think that this is precisely the gravest danger the ECB's current policy stance is creating. The boom-and-bust see-saw in the euro area is likely to simply shift from South to North this time around, with the previous 'sick man of Europe' becoming the center of a new bubble, while the periphery goes through a depression. Obviously it is impossible for the central bank to keep such developments under control. This is also why we believe that the ECB's obsession about the 'monetary policy transmission' problem is quite unhealthy. If interest rates in euro area countries were simply left to the market, they would certainly be diverging quite a bit, and it is a good bet that German rates would be higher than they actually are at present. Central planning of money doesn't work, and it does even less so in the euro area.
It is that time of the year again – our semi-annual funding drive begins today. Give us a little hand in offsetting the costs of running this blog, as advertising revenue alone is insufficient. You can help us reach our modest funding goal by donating either via paypal or bitcoin. Those of you who have made a ton of money based on some of the things we have said in these pages (we actually made a few good calls lately!), please feel free to up your donations accordingly (we are sorry if you have followed one of our bad calls. This is of course your own fault). Other than that, we can only repeat that donations to this site are apt to secure many benefits. These range from sound sleep, to children including you in their songs, to the potential of obtaining privileges in the afterlife (the latter cannot be guaranteed, but it seems highly likely). As always, we are greatly honored by your readership and hope that our special mixture of entertainment and education is adding a little value to your life!
Bitcoin address: 1DRkVzUmkGaz9xAP81us86zzxh5VMEhNke
One Response to “The ECB Rate Decision – A Brief Comment”
Most read in the last 20 days:
- A Striking Chart
The Economy and the Stock Market As long time readers know, we are always paying close attention to the manufacturing sector, which is far more important to the US economy than is generally believed. In terms of gross output it is the largest sector of the economy, and it should of course be obvious that saving, investment and production are the only ways to create wealth. What's left of the Brooklyn Domino Sugar Refinery. Photo credit: Paul Raphaelson Contrary...
- Trump and Putin Narrowly Escape Assassination Attempt
The Gloves are Coming Off First a little bit of recent history. Readers are probably aware that some questions about the occasionally malfunctioning Deep State android... no, wait, we'll start again. Questions have recently been raised about the health of presidential candidate Hillary Clinton by various “alt-right” tinfoil hat-wearing conspiracy theorists, such as this one. The monsters are normally hiding under Hillary's bed, but lately they have come out into the open...
- Why the Fed Destroyed the Market Economy
What Have You Done for Me Lately? Swing voters are a fickle bunch. One election they vote Democrat. The next they vote Republican. For they have no particular ideology or political philosophy to base their judgment upon. The primacy of the wallet. They don’t give a rip about questions of small government or big government. Nor do they have any druthers about the welfare or warfare state. In effect, they really don’t care. What’s important to the...
- Donald’s Electoral Struggle
Wicked and Terrible After touting her pro-labor union record, the Wicked Witch of Chappaqua rhetorically asked, “why am I not 50 points ahead?” Her chief rival bluntly responded: “because you’re terrible.”* No truer words have been uttered by any of the candidates about one of their opponents since the start of this extraordinary presidential campaign! Electoral map (note that the coloration may no longer be applicable...) That Hillary Clinton is...
- Janet Yellen’s Shame
Playing Politics In honest capitalism, you do what you can to get other people to voluntarily give you money. This usually involves providing goods or services they think are worth the price. You may get a little wild and crazy from time to time, but you are always called to order by your customers. In the market economy, consumers reign supreme. There is no such thing as a “lost” vote in the marketplace; every penny spent affects production. Mises noted: “Consumers...
- Get Ready for a New Crisis – in Corporate Debt
Imposter Dollar OUZILLY, France – We’re going back to basics here at the Diary. We’re getting everyone on the same page... learning together... connecting the dots... trying to figure out what is going on. The new three dollar bill issued by the Apprehensive States of America. We made a breakthrough when we identified the source of so many of today’s bizarre and grotesque trends. It’s the money – the new post-1971 dollar. This new dollar is green. You...
- The Economy, the Stock Market and the Fed
John Hussman on Recent Developments We always look forward to John Hussman's weekly missive on the markets. Some people say that he is a “permabear”, but we don't think that is a fair characterization. He is rightly wary of the stock market's historically extremely high valuation and the loose monetary policy driving the surge in asset prices. The S&P 500 Index and the NYSE advance-decline line. Most market internals weakened steadily until early February 2016, but...
- Hanjin Marooning in San Pedro Bay
Global Trade Reversal Expansions and contractions in global trade have played out over long secular trends for thousands of years. The Silk Road, for example, was established by the Han Dynasty of China in 130 BC, and allowed for continuous trade between East and West for nearly 1,600 years. In addition to economic trade, the Silk Road was also a conduit for culture and knowledge among its network of civilizations. A map of the main ancient Silk Road - click to...
- Great Causes, a Sea of Debt and the 2017 Recession
Great Cause NORMANDY, FRANCE – We continue our work with the bomb squad. Myth disposal is dangerous work: People love their myths more than they love life itself. They may kill for money. But they die for their religions, their governments, their clans... and their ideas. Famous French hippie and author Voltaire. He wears the same sardonic grin in every painting, whether he's depicted at a young or an old age, doesn't matter. His real name was François-Marie Arouet; he...
- The Donald Versus Killary: War or Peace?
War: A Warning from the Past Although history does not exactly repeat itself, it does provide parallels and sometimes quite ominous ones. Such is the case with the current U.S. Presidential election and the one which occurred one hundred years earlier. The Donald probably has the better slogan... The dominating question which hung over the 1916 campaign was whether the country would remain neutral in regard to the horrific slaughter which was taking place on the...
- A Rift in the Space-Time Continuum
Weird and Unnatural NORMANDY, France – First, a quick look at the markets. The Dow bounced on Monday, recovering 239 points of the nearly 400 it lost on Friday. Why the comeback? FOMC member Lael Brainard: her comments on Monday were touted as the “reason” for the stock market recovering half of Friday's losses. We suspect the real reason is the triple witching on Friday... Photo via twitter.com The financial press has a ready answer: “Stocks gain...
- Crimea: Digging For The Truth
Renewed Escalation This summer witnessed a renewed escalation between Russia and Ukraine after Russian President Vladimir Putin accused Ukraine of sending saboteurs to attack Russian troops, targeting “critical infrastructure”. Kiev denied the allegations and claimed Russia’s “fantasy” was nothing but a false pretense to launch a “new invasion”. August 10: Russian president Putin announces that there was an altercation involving a group of Ukrainian saboteurs at...