Burning questions for the ECB
On Thursday 26th October, the European Central Bank is holding its Governing Council meeting. This meeting will be closely watched by many, as important changes to the quantitative easing programme are expected to be announced.
For the past two years we have persistently argued that QE is not the optimal response to the economic slowdown in the euro area, because it does not stimulate growth effectively, and it leads to a number of undesirable side-effects. We share the view that a reduction in the size of QE is timely and desirable. However, some form of monetary stimulus is still needed to support the weak economy and to achieve the ECB’s price stability objective.
We believe the ECB’s upcoming announcement provides an opportune time to assess the overall outcome of the ECB’s 2 trillion euro programme and to bring about other specific issues that we think would be relevant to question the ECB upon.
1. How does money created under QE reach the real economy?
As recently explained by the Bundesbank in a research paper, commercial banks create most of the money in circulation by issuing loans. In practice, this means commercial banks do not need pre-existing central bank reserves in order to produce loans. In that environment, the ECB policies can only influence credit markets prices and conditions, but the actual transmission mechanism depends very much on the level of demand for loans. If companies don't want to borrow to invest, or commercial banks don't want to lend to them, there is nothing the ECB can do about it.
After 3 years of QE, what evidence does the ECB have – beyond the improvement of lending conditions – that the asset purchases have increased demand for credit in the real economy?
2. How to make QE support investments?
The Eurozone is witnessing a slow recovery of growth and inflation, but there is ample evidence that this is mostly due to external factors such as energy prices and exports. On the other hand, domestically generated growth remains weak, notably due to the fact that investment levels have not recovered their pre-crisis levels. To make sure that the recovery is self-sustained, there is need for investment to pick up. As outlined by a report from the European Economic and Social Committee (EESC), more coordination between the ECB and the European Investment Bank could be a pragmatic way to make QE more effective in that regard.
How can policymakers at EU or member states level make the best out of QE before it ends? Have the ECB envisaged ways to calibrate the QE programme in such a way that it supports investments more effectively? Can a more concerted effort with the European Investment Bank be helpful?
3. Is the ECB bound by the Paris agreement?
In a recent letter to Green MEPs, Mario Draghi said: “The ECB shares the view that achieving the environmental goals of the Union, including those set out in the Paris Agreement, is of great importance to our societies.” Draghi also referred to the ECB’s mandate by saying that the ECB’s secondary objective to “support the general objectives of the EU” could include the protection of the environment. However, it is unclear in the letter whether the ECB formally shares the view that the Paris agreement is binding for the ECB.
Has the ECB done a legal assessment on whether the ECB is formally bound by the Paris agreement? And if yes, what initiative could the ECB take to help fulfill the climate change objectives of the EU?
4. Can the ECB decarbonize its corporate bond purchases?
A number of NGOs and academics have criticized the corporate sector programme (CSPP) for its negative environmental impact, by arguing that many of the bonds being purchased by the ECB are linked with the fossil fuel industries, or even corporations doing tax evasion and so forth. A survey by the Dutch National Bank also indicated that corporate purchases are more likely to spur distrust towards the ECB than other forms of monetary stimulus including “QE for the People.”
Has the ECB undertaken any initiatives in order to best align its monetary policy programmes with best practices in terms of social and environmental indicators? Has the Governing Council discussed any changes in the composition of the CSPP programme in order to make progress on this?
5. Improving the transparency of quantitative easing
As part of its transparency efforts, the ECB recently released an aggregated list of the securities purchased by the Eurosystem, in addition to further details on the sectoral composition of the CSPP programme. However civil society groups and MEPs still think that more can be done, especially in contrast to the higher degree of transparency of other central banks in that respect. The Federal reserve for instance do disclose the volumes of its Mortgage-Backed Securities purchases.
Has the ECB considered releasing the volumes of the CSPP purchases and other segments of its QE programme? What would refrain the ECB from publishing the date after a reasonable delay? Finally, when the programme ends, will the ECB reveal the data in full?
6. Transparency and openness of the ECB’s advisory groups
Corporate Europe Observatory recently published a report criticizing the lack of transparency of the ECB’s contact groups that the ECB hosts. Out of 517 available seats across all 22 groups, no less than 508 have been assigned to representatives of private financial institutions. In particular, the report reveals that some members of those advisory groups were directly involved in the EURIBOR and Volkswagen scandals.
Has the ECB taken stock of the criticism and is it going to take measures to improve the transparency and openness of those advisory groups for civil society?
7. Are the determinants of inflation well-understood?
The financial community is intensively debating whether some of the central banks’ conventional theories do still work in the current context. For example, a persistent low-inflation environment seems to indicate that the Phillip's curve is flatter than we used to think. Recently, former Fed governor Daniel Tarullo bluntly said that central bankers “do not, at present, have a theory of inflation dynamics that works sufficiently well to be of use for the business of real-time monetary policymaking.”
Asked on this topic by Larry Summer at a PIIE panel, Mr Draghi responded with: “it does not make any difference, as far as monetary policy is concerned ... because inflation is a monetary phenomenon.” Yet, the evidence increasingly shows a decoupling of the correlation between the ECB’s monetary base and headline inflation, whilst other factors, such as commodity prices, seem to play a bigger role. Another school of thought also considers inflation as a monetary phenomenon, but in a highly financialized economy inflation also manifests itself in asset prices as opposed to retail price inflation only.
What is the ECB’s theory of inflation? If inflation is a monetary phenomenon, does the ECB take into account asset prices in its headline inflation index? Does the ECB distinguishes domestically generated inflation vs. inflation that stems from external factors?