News Column

ECB's actions are no panacea for Europe's economy

June 7, 2014



Central banks can't fix everything.



The European Central Bank took bold steps on Thursday to protect Europe's fragile economic recovery, cutting interest rates and offering to pump more money into the financial system.







Economists generally praised the moves, which are designed to raise dangerously low inflation in the 18 countries that use the euro and encourage lending. The ECB's steps could also make exporters more competitive by reducing the euro's value and thereby making Europe's goods less expensive abroad.







But they say Europe's economy won't return to health until it receives long-term fixes that the ECB can't provide on its own.







The ECB's "actions will help, but only on the margin," said Mark Zandi, chief economist at Moody's Analytics. "This will be a very long road."







Zandi says banks across the continent must strengthen their own finances, possibly with taxpayer help, before they're healthy and confident enough to ramp up lending. Countries such as Italy and France need to revamp regulations that discourage businesses from hiring. They must, for instance, make it easier for employers to cut wages, rather than lay people off, during hard times. And Germans, far more prosperous than their neighbors, need to buy more products and services from the rest of Europe.







Compared with other central banks around the world, the ECB has been a laggard. The US Federal Reserve and other central banks long ago used up their traditional tool for fixing economies cutting short-term rates to near zero and then unleashed more untested measures. The Fed, the Bank of Japan and the Bank of England have aggressively bought government bonds to try to push long-term rates lower and thereby encourage borrowing and spending an unconventional policy known as "quantitative easing" or QE.







The ECB has balked at going that far. It balked again Thursday. But President Mario Draghi said the ECB would prepare for a programme to buy bonds made up of loans to small businesses. The idea would be to accelerate lending to small companies.







For the first time in its history, the ECB will start charging banks for depositing money at the central bank. This step called a negative deposit rate is intended to nudge banks to lend rather than hoard cash. Draghi pledged to do still more, raising hopes among investors that he will pursue a big Fed-style bond-buying program in the future. "Are we finished?" he said at a news conference. "The answer is no."







The eurozone clearly needs the help. Its economy grew just 0.2 per cent the first three months of the year from the October-December quarter. Inflation is running at a perilously low 0.5 per cent.







Excessively low inflation is unhealthy. It makes it harder for consumers, companies and countries to repay debt left over from the eurozone's financial crisis. And it raises fears of an outright drop in prices deflation. Deflation can kill economic activity and business profits by causing people to delay purchases in anticipation of even lower prices.







Draghi succeeded in reassuring investors that the ECB will act aggressively to sustain the eurozone's recovery and raise inflation. Analysts had feared a market sell-off if the ECB had done something half-hearted. Instead, stocks rose Thursday in the United States and Europe.







But many analysts doubt that the benefits will endure. "It's not going to make the slightest difference" in the long run, said David Kelly, chief market strategist at J.P. Morgan Funds.







European banks aren't lending much not because interest rates are too high. It's mainly because Europe's banks lack confidence. They fear that other banks across Europe are holding too many bad loans and that the European banking system is vulnerable to a repeat of the financial crisis of 2008-2009.




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Source: Khaleej Times (United Arab Emirates)


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