Saturday 23 February 2019

ECB goes further through the monetary looking-glass

Brendan Keenan

Brendan Keenan

Beware the pub questioner. Surprisingly often, they ask very good questions, and they expect a quick answer. "Why doesn't the ECB just give me the money - I'd know how to spend it," was one such the other week, albeit delivered a trifle truculently.

Going through the mechanics of quantitative easing was clearly not the way to answer, even if one had felt up to the task. "You're dead right," seemed safer.

A better answer too, as it turns out. Last week, the ECB went a good bit down that road. They are not yet ready to put money straight into the guy's pocket, but they are prepared to give his bank money if it offers him a loan.

A lot of eminent people think they should give the man in the pub what he wants. Some call it "helicopter money," summoning up visions of banknotes fluttering down from the sky.

The reality is a bit more prosaic. Central banks would create the stuff and lend it to governments and they, as we know, are always keen to distribute goodies to the populace.

The arguments as to whether they should do so, and to what extent, have raged endlessly since the Crash. As to the money already in existence, it earns little or nothing if lent to banks or governments.

Banks themselves have to pay to leave their funds with the ECB and may now get paid if they take it away and lend it.

Only Lewis Carroll and Alice's looking-glass could do justice to this topsy-turvy system. We know the problem - or rather we know its symptoms - but could this possibly be the answer? For the moment, not only is it the answer but we are to have more of it.

Quite a lot more, according to ECB president Mario Draghi last week. As well as bringing the main interest rate to zero, the ECB is to create an extra €20bn a month to buy other bodies' loans, which for the first time will include corporate loans. There are to be more cheap loans - even payments - for commercial banks to lend on to households and firms.

These are steps, however tentative, towards the helicopter pad but questions remain as to whether they are enough. They can be summed up as, will it work, is it wise and also, is it fair?

It is painfully obvious that central banks have failed in their main objectives but there is evidence that things would have been worse without these actions. It is hard to argue with Mr Draghi's claim that the Eurozone would have suffered severe deflation had Frankfurt not fuelled the system with all that money.

This is an important political point. The ECB's mandate is the maintenance of price stability. Inflation hovering either side of zero does not meet the mandate. This has allowed Mr Draghi and a majority of national governors sweep aside German-led objections to the printing of so much money and its use to buy government bonds.

The new programme was approved by 21 to 4 on the ECB Governing Council, so the presses will be running until at least this time next year. That may be prevent a deflationary mindset becoming established (as it is, who now expects prices to rise?) but the focus may still be too narrow to achieve the wider objectives.

Fund manager Eric Lonergan, best known for supporting 'The Big Issue's' investment arm (yes, it has one) has even suggested the ECB's mandate obliges it to deliver helicopter money, because it may be only way to restore price stability, as officially defined.

One difficulty with the existing scheme is that economic problems are concentrated in the peripheral, indebted countries but the scheme does not particularly favour them. Political imperatives created a system whereby national central banks, not the ECB, carry the risk of default on 80pc of their governments' bonds bought by the ECB; and the allocation is based on the size of the country.

This is a logical absurdity, as pointed out by MEP Brian Hayes. Sharing the risk equally, and injecting money according to the size of national debt, would reduce interest rates in countries like Italy, Spain and Ireland towards the euro average; although with 8pc GDP growth knocking huge chunks off the debt ratio, it is no longer clear exactly where Ireland fits into the general scheme of things.

Ireland does illustrate the problem though.

The public finances have benefited enormously from the government being able to borrow at less than 1pc. But the private finances of those unable to service their mortgages, or struggling with variable interest rates above 4pc, have not improved. Government has been unable, or unwilling, to pass on some of its gains to the indebted, rather than just the vocal.

Then there are the dangers. There are particular problems for insurance companies and pension funds from the paltry returns to be earned on their financial reserves.

Banks which want to attract deposits have to provide loss-making interest rates. Either that, or they may be tempted to make risky, higher-yielding loans. The infamous Central Bank mortgage limits are part of the "macro-prudential" measures designed to limit bank risks - but they also run counter to the objective of creating more demand from companies and households.

It may be the case that already, Ireland no longer needs more demand from households, but should concentrate on the households with particular problems. There is scope for more investment by both government and parts of the private sector - especially construction and small firms.

In dealing with this, it won't be enough to have a new government, even if it is a stable one. It will have to be cleverer and more determined than its recent predecessors if it is to cope with the problem of Ireland again being out of step with the rest of the Eurozone - and in more ways than its faster growth rate.

Alongside the spectacular growth, it has a highly vulnerable banking system, as highlighted in the recent IMF country report.

Negative interest rates make weak banks even more vulnerable (interestingly, Mr Draghi says that's it as far as interest rate cuts go, although ECB chief economist Peter Praet seemed to take a different tack.)

As to fairness, QE penalises small savers, including those saving for a pension, while benefiting those rich enough to have had their wealth in things like government bonds and property, where values have soared as saving rates tumbled.

In Ireland, the sad truth is dawning that most of those gains have accrued to foreigners as Irish wealth disappeared in the ocean of debt. Another is that the helicopter drop, however popular, is not what this country needs most.

It is still all about debt and assets: reducing one and building up the other.

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