The European Central Bank ramped up its battle against deflation overnight. But without help from Germany, the battle will be a long drawn-out affair with no end in sight. For the recovery to gain momentum, countries within the eurozone must put aside their narrow self-interest and fulfil the promise of the euro by working together towards a cause far bigger than themselves.
Last night the ECB became the first major central bank to cut rates below 0 per cent. Its deposit rate, applied on excess reserves placed at the ECB by banks, was cut to -0.1 per cent. The ECB also decided to cut its main refinancing rate by 10 basis points and the marginal lending rate by 35 basis points, though neither is expected to have a significant economic impact.
This decision follows recent data which showed that annual inflation in the eurozone slowed to just 0.5 per cent over the year to May. The result was softer than expected and well below the ECB’s target for inflation of about 2 per cent (The heavy toll of eurozone inaction, June 4).
To address the continued declined in business credit, the ECB announced an offer of four-year loans, which are designed to encourage banks to lend to small and medium-sized businesses. The offer will allow access to up to €400 billion of cheap loans, equivalent of 7 per cent of outstanding loans to businesses and households (excluding mortgages).
The program appears similar to the Bank of England’s Funding for Lending program with one important difference: it will not be accessible for mortgage lending. The BoE program boosted lending to households but had little impact upon business credit.
The ECB stopped short of announcing a roll-out of quantitative easing but the lending facility was more generous than expected and the more targeted approach could prove beneficial. Nevertheless, leaving all the heavy lifting to the ECB is fraught with danger, particularly since it has exhausted its conventional policy options.
The best way to increase inflation and boost lending to the private sector is to increase domestic demand. Unfortunately monetary policy is not the most efficient mechanism to get this done. Steps by the ECB -- no matter how well-intentioned -- will provide only minor support to an economic region that needs so much more.
The International Monetary Fund believes that German chancellor Angela Merkel needs to do more to support growth across the eurozone.
It noted that Germany could finance additional investment of “up to 0.5 per cent of GDP a year over four years … without violating fiscal rules”, the stimulus “would have only a minor impact on debt-to-GDP ratio given the growth offset”. As it stands, the fiscal rules that have proved so devastating for the euro periphery are effectively irrelevant for Germany, such is their power within the European Union.
Domestic demand in Germany has been quite weak (although it did drive growth in the March quarter) with exports remaining a key factor in their success. A boost to investment in Germany, combined with actions by the ECB to reduce the euro, would provide a much needed boost to exports across the euro zone.
Of course, this need not be a selfless act by the Germans; they would benefit as well. Faced with some nasty demographics and a rapidly ageing population, they could utilise low lending rates to fix their crumbling infrastructure and put in place the necessary steps to ensure that their economy is well placed to meet the needs of an older population.
Monetary policy by itself will not be enough to put this recovery on a sustainable path, though the decision to provide cheap loans to small and medium-sized businesses is a welcome development.
The ECB needs help and that help should come from Germany. They have at times been selfish throughout this economic crisis, with little appreciation for the consequences of long-term unemployment or the economic hardship they have imposed upon other countries, but they are better placed than anyone to put money in the hands of those who need it: households and businesses.