Lagarde perfectly capable of facing down her ECB sceptics

Wed, Nov 20, 2019 – 5:50 AM

CHRISTINE LAGARDE has taken the helm of the European Central Bank (ECB) at a time of rising scepticism over the power of monetary policy. Critics say that the central bank has no tools left to bring inflation back to its target of close to, but below, 2 per cent. The ECB is now a helpless bystander, they claim, as the power to foster a recovery sits squarely with elected governments.

There is little doubt that as the central bank digs deeper into its toolkit, some of its policies risk becoming less effective. But there is plenty more that the ECB can do, from further rate cuts to more flexible asset purchases.

And while the question over what to do next is largely political, Ms Lagarde's efforts to listen before she leaps and address tensions within the governing council head-on should provide a clean slate from which to take any difficult decisions down the road.

Defeatist case

The defeatist case against the ECB starts from how far the central bank has already gone. In September, it cut the deposit rate to -0.5 per cent and restarted net asset purchases. For some, that means the central bank cannot cut rates further without harming the economy. What's more, within roughly a year, the ECB could hit its own self-imposed limits on its programme of quantitative easing (QE). Of course, the more the central bank presses on the monetary accelerator, the harder it is for its measures to push up the inflation rate and stimulate growth. But economists at the ECB still have tools that they can use. For a start, they know they can lower the deposit rate further. An ECB working paper has shown that negative rates have not dissuaded savers from storing their money in a bank. Moreover, when banks have passed sub-zero rates on to corporations, it has sparked them to increase their investment – which is the point of the policy. There are legitimate concerns over risks to financial stability, but these can be addressed via other levers, including higher loan-to-value ratios.

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The concerns over quantitative easing are also overblown. The ECB has decided that it will purchase bonds according to each country's shareholding in the central bank and will not hold more than a third of any eurozone country's sovereign debt.

As Germany's public debt shrinks, and the central bank purchases more securities, the limit of how many bunds it can hold risks becoming binding soon.

But the ECB has shown itself to be flexible in the past in terms of how precisely it needs to stick to some of these self-imposed constraints. In extremis, the governing council could scrap these ceilings and replace them with more generous ones. Finally, there are other, more extravagant avenues the ECB could explore, which would take it closer to fiscal policy. Mario Draghi, Ms Lagarde's predecessor, described the constraints of any intervention in his departing speech. "The euro area is built on the principle of 'monetary dominance,'" he said. "Monetary dominance does not preclude communicating with governments when it is clear that mutually aligned policies would deliver a faster return to price stability. It means that alignment between policies, where needed, must serve the objectives of monetary stability," he added.

The question is how far Ms Lagarde will want to push against the resistance from her fellow central bankers. She inherited a deeply split governing council, so much so that she make her first meeting an off-site retrRead More – Source