Mario Draghi and the ECB go through the looking glass

Yesterday I examined the fiscal plans of European Commission President Jean-Claude Juncker via the lens of Lewis Carroll’s writings.This morning European Central Bank President Mario Draghi has given a speech to the Finnish parliament and I intend to take the opportunity to put the policy of the ECB under the microscope. Will Euro area monetary policy be in step with fiscal policy and will both of them be pro or anti cyclical?

What have we been told?

We have got a familiar refrain from Mario Draghi this morning. Here is his summary of the Euro area economy.

We have seen a weakening in the euro area’s growth momentum over the summer and the euro area economic outlook is surrounded by a number of downside risks……..Inflation in the euro area remains very low, standing at 0.4% in October. In the light of the recent sharp fall in oil prices, and taking into account prevailing futures prices for energy, inflation is expected to remain at around current low levels over the coming months, before increasing gradually during 2015 and 2016.

Remember the days when central banks used to forecast that inflation would fall back to target. Now the same magic wand has it rising towards it! Lewis Carroll would have seen it like this.

I’m not strange, weird, off, nor crazy, my reality is just different from yours.

We advance with Mario Draghi just having given a rationale for extremely expansionary monetary policy. Although we do have an issue with this bit.

During the past crisis years, the ECB has acted forcefully to safeguard price stability

Actually what we currently have (inflation at 0.4%) is close to price stability and the ECB wants to take the Euro area away from that! This is central banker speak for lets help with the debt problems and hope that our words sound/read so impressively that the media just copy and pastes what we tell them.

Be what you would seem to be – or, if you’d like it put more simply – never imagine yourself not to be otherwise than what it might appear to others that what you were or might have been was not otherwise than what you had been would have appeared to them to be otherwise.

What is the policy prescription?

First we get a confession of one of the main themes of this blog.

While these measures have been successful in improving banks’ access to private credit and countering financial fragmentation, broader financing conditions – foremost the cost of borrowing from banks – have been exceptionally sluggish in responding to the monetary policy accommodation that was introduced.

Translating the central banker speech we see that he is admitting that policy has helped the banks rather than the real economy.

Today’s data

I wish to skip to this as it has reinforced an element of this. The ECB is pumping it up but it is not reaching the areas it would like it too. Here is the “pumping it up” section.

the annual growth rate of M1 stood at 6.2% in October
2014, unchanged from the previous month.

But by the time it has reached private-sector loans it has been converted to this.

adjusted for loan sales and securitisation,
the rate stood at -0.5%, compared with -0.6% in the previous month.

So a marginal improvement but also a continued decline. Poor Mario and all his impressive sounding measures. Back in the day when we were looking at the other side of the coin this was called disintermediation.

How will Mario respond to this?

Apparently it will not be through the further use of the interest-rate weapon and the emphasis is mine.

In September, we cut the key ECB interest rates to their lower bound. The main refinancing rate now stands at 0.05%, and the deposit facility rate at -0.20%.

Here we have central bankers contradicting each other as the Governor of the Bank of England Mark Carney told us the lower band was 0.5% only two days ago, whereas Mario seems to have it at either 0.05% or -0.2%! Aren’t you glad that is clear?

How puzzling all these changes are! I’m never sure what I’m going to be, from one minute to another.

The main player going forwards is going to be the balance sheet of the ECB as Mario tells us one more time.

They will also have a sizeable impact on our balance sheet, which we expect to move towards its early 2012 dimension.

If we look back we see that the ECB balance sheet peaked at 2.99 trillion Euros back then so let us round it to 3 trillion. Now it is 2.03 trillion Euros so if you read that a one trillion Euro expansion is intended that is where they get the numbers from. You may note that this would be a 50% increase.

The ECB has impressive sounding programmes for this

The covered bond programme has purchased some 12.7 billion Euros of bonds so far and purchases of asset backed securities are beginning. So we do have an example of private-sector Quantitative Easing. But there is a Houston we have a problem moment. You see at the end of October the ECB balance sheet was at 2.052 trillion Euros and yes up is the new down one more time as expansion involves it shrinking!

My dear, here we must run as fast as we can, just to stay in place. And if you wish to go anywhere you must run twice as fast as that.

Actually under the current rules Mario is running as fast as he can but he is not quite managing to stay in place so far. He must feel rather like this.

The rule is, jam tomorrow and jam yesterday-but never jam today

It must come sometime to jam today, Alice objected

No it can’t said the Queen It’s jam every other day. Today isn’t any other day, you know.

How can Mario get jam today?

On this road we find the concept of sovereign bond Quantitative Easing hovering in the distance as an apparent prize. The financial markets certainly seem to think so as the prices of Euro area government bonds are surging again today and yields are falling. For example CNBC are reporting this about the ten-year benchmark German bund this morning.

another record low for 10 German Bund yields at 0.71%

Another way of putting this is that the equivalent yield for France looks as though it too will join the sub 1% club as it has fallen to 1.01% as I type this.

There is of course a catch here as if markets are already pricing in a substantial amount of ECB QE reality could easily disappoint. This is a theme of this blog where the Frenchman in the film Matrix revolutions was wrong about “cause and effect” as here we have effect before the cause. This also happened (in my opinion) with the fall in the UK Pound in 2007/08.

The problems of QE

There is an implicit assumption that this is some form of Holy Grail with the current arch-priest being represented by Ambrose Evans-Pritchard of the Daily Telegraph. However it is far from a Holy Grail and we should for example not listen to hedge fund managers with portfolios stuffed full of Euro area bonds for advice!

Right now Japan for example has plenty of QE but its economy is struggling for both growth and inflation. Indeed it has returned to recession. Around the world we have had quite a lot of QE but we seem to be slipping back into the economic quicksand again don’t we? In my opinion there are circumstances where it can be deflationary and others where it is inflationary. Right now QE is really just another piece on the chessboard of currency wars as the currencies are the main players.

You see if reducing bond yields had a powerful economic effect both France and Germany amongst others would have already seen it would they not?

Contrariwise,” continued Tweedledee, “if it was so, it might be; and if it were so, it would be: but as it isn’t, it ain’t. That’s logic


Over the past two days I have been very critical of Euro area policy as we have covered both monetary and fiscal issues. However I do have a lot of sympathy for both the ECB and Mario Draghi as it is the weaknesses and failures of elected politicians which have put both him and the institution between a rock and a hard place. Again Lewis Carroll’s words echo through the years.

But I don’t want to go among mad people,” Alice remarked.
“Oh, you can’t help that,” said the Cat: “we’re all mad here. I’m mad. You’re mad.”
“How do you know I’m mad?” said Alice.
“You must be,” said the Cat, “or you wouldn’t have come here.

After all if the oil price remains at these levels (US $76 for a barrel of Brent Crude Oil) we may have a clear fail as the policy expansion coincides with an oil price driven reflation.

Let me end by wishing American readers a Happy Thanksgiving and as a cricket fan let me extend my deepest sympathies to the family and friends of Phil Hughes.


14 thoughts on “Mario Draghi and the ECB go through the looking glass

  1. ‘Be what you would seem to be – or, if you’d like it put more simply – never imagine yourself not to be otherwise than what it might appear to others that what you were or might have been was not otherwise than what you had been would have appeared to them to be otherwise.’.

    wow – would that be the unknown known unknown, translated from American into, er, something else?

    Nice summary Shaun, looks rather like a hard place and any number of rocks …

    • Hi dl and thank you

      I would rather quote Lewis Carroll than Donald Rumsfield if given a choice!

      One of the ironies of our time is that one of the rocks is a falling oil price (Brent US $73 as I type this) because the ECB concentrates so much on its 2% inflation target. We could yet see a Euro CPI 0% print …..

      Meanwhile the economic boost will presumably be ignored. Oh what a tangled web and all that.

  2. Thank you, Shaun. I didn’t know that jam tomorrow came from “Alice in Wonderland”.

    Did you read Simon Ward’s “Eurozone recession fears echo misplaced 2013 recession” column last Friday on your old website? He believes the euro area is likely to have 1-2% growth in 2015 despite the fact that the IMF thinks “there is a 40% chance of a Eurozone recession by mid-2015. The IMF’s forecasting record is poor and it is often an excellent contrarian indicator.” He notes that there was a 3.2% six-month next year. Do you believe he’s right?

    In Canada, following the monetary aggregates seems to have fallen out of favour. The Monetary Policy Review never referred to them in its last issue. However, it seems like a lot of British economists, like Mr. Ward, still follow them closely.

    • Hi Andrew,
      To my mind, I think Shaun has already said it all in his ECB quote – “the annual growth rate of M1 stood at 6.2% in October”. Expect the OVERALL increase EZ GDP in Q2 next year.

      The QE, if it happens, which still requires German agreement and seems more likely with each passing day is neither here nor there to me, other than to help reduce sovereign borrowing costs, help the bond vigilantes and expand further an already immense “asset(liability?” bubble.

  3. I have NO sympathy for the squid Draghi. He cares nought for the people and only for his precious rich bankers. The answer involves bringing back capitalism, let mkt set rates, stop interfering etc

    • Hi Jonathan

      I have no love for the way that the Vampire Squid has placed its alumni in important positions either. I think that someone pointed out that there were nine of them heading central banks in Europe and compared them to the Nazgul.

      However the ECB has been put under a squeeze by the failings of politicians.

  4. Hello Shaun

    Margo and junkers , these people hold power without representation – and then compound it with bombastic and ridiculous remarks that seems to indicate a severe learning disorder !

    pffft!! – Who will rid the us of these troublesome priests?

    As for oil , its seems to have hit a bump on the way down , but short term it’s sentiment that will determine price ….

    um, it seems OPEC and Mario / junk share the same methods = lots of talk to achieve results without doing anything in reality……

    And predictably with the same results !!!


    • Hi Forbin

      I guess that by now you have seen the oil price news with it falling 7% today as the Saudis presumably decided to put a real squeeze on those who have higher costs. As I have replied to others it poses a real issue for the ECBs inflation target whilst boosting growth…

  5. Hi Shaun and thanks for this interesting blog.
    May I endorse your best wishes to all Americans at this special time for them and great sympathy to all family and friends of the great Phil Hughes.
    “And what if oil stays around these prices” updated since you blogged.

    • Hi Midge and thank you

      As to the oil price it is hard to believe that as recently as November 20th I thought that the oil price (Brent Crude) falling below US $78 was a big deal. Now it is below US $73 tonight! We need to see for how long it is at these levels but the longer it does the more of an overall economic boost the world economy will get.

  6. Hi Shaun,

    Why would QE in the face of a falling oil price be a clear fail?

    In a sense it would act counter cyclically as the Euro falls against the $ in such a scenario reducing the disinflation and growth effects which may help avoid an overheating EZ in 1 – 2 year’s time followed by the inevitable bust. I just don’t think it’s as simple as it would appear at first glance.

    • Hi Noo2

      The objective of monetary policy is to be counter-cyclical and there are reasons for thinking that next year will be a better year for the Euro area. The ECB is at least trying to keep its balance sheet from shrinking and now assuming that oil prices remain on a lower trajectory there will be a boost to growth from it. So if QE starts in 2015 it will be around 2/3 years too late.

      In my view it makes the Euro area more likely to overheat….

      • “The objective of monetary policy is to be counter-cyclical” Now tell Mario that. I stand by my first comment – the QE, as I said above is weakening the Euro against the dollar thereby acting countercyclically to the oil price fall although of course EZ products then become cheaper as exports. As UI said above, it’s just not that simple.

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