The Open Mouth Operations of Mario Draghi have a shorter and shorter half-life

There is much to consider in the current financial market turmoil and as central banks are such major players today there is much to consider for them too. They have slashed interest-rates and many have expanded their balance sheets considerably via the use of QE (Quantitative Easing) yet we are where we are. Many will be wondering if the current indigestion in financial markets has been caused by a single 0.25% interest-rate hike by the US Federal Reserve. Only a couple of weeks or so ago the Open Mouth Operations of the US Fed were promising another four of those in 2016 but that looks like another mirage right now. This returns us to the long-running junkie culture theme of this blog where the continual interventions of central banks have left financial markets and to some extent economies dependent on them. On that subject let me address the words ( yes more OMO! ) from Mario Draghi of the ECB last night.

What did Mario Draghi say?

In what is becoming a familiar theme for central banking speeches Mario opened by blaming foreigners. There is an obvious catch with that if everyone does it.

The euro area has started the New Year facing two opposing forces: a strengthening domestic economy and a weakening global one.

What is Italian for “Johnny Foreigner” please? The detail was interesting as well.

At home, the recovery is proceeding, with consumption as the main driver. That is being supported by our accommodative monetary policy, falling energy prices and a neutral fiscal policy. Employment is rising, up by over 2 million people compared with the trough in 2013.

There is good news for the Euro area economy which has improved as we have regularly discussed and there are 2 million clear reasons to welcome that. However Mario has contradicted himself as  the “falling energy prices” have been driven by the foreign events he has just blamed. Also you may note what is a savaging of the Euro area political class and establishment in “a neutral fiscal policy”. Or you can look at it as Mario taking all the credit for himself.

Inflation Inflation

President Draghi opens fire here with a misrepresentation and an odd connection.

The ECB has a central role to play in supporting confidence. We do that by fulfilling our price stability mandate: an inflation rate of below, but close, to 2%.

The misrepresentation is the use of a 2% annual inflation rate as plainly 0% would be price stability as language gets twisted again. Also there is the rather odd idea that a number which was picked out of thin air in some way gives “confidence”! Next came an attempt to hide a rather awkward confession.

With inflation already low for some time, we saw a danger that a continued period of low inflation – even if oil-driven – might destabilise inflation expectations and become persistent.

That is a description of failure by the ECB and yet we are told this.

And we chose to respond by recalibrating the APP because we have ample evidence that it works.

He means the Asset Purchase Program by APP and he continues with the emphasis being mine.

Since the middle of 2014, when we launched our credit easing package, bank lending rates have fallen by 80 basis points for the euro area, and by between 100 and 140 basis points in the countries hit hardest by the crisis. To put that in perspective, to have a similar impact on lending rates with conventional policy would’ve required a one-off rate cut of 100 basis points.

The problem with in effect singing along with last summers hit cheerleader is that you immediately hit trouble. After all Mario Draghi has just confessed that the perceived inflation problem has just got worse! If you re-read his quote he has just told you that not only has 60 billion Euros not worked in that regard but a 1% interest-rate cuts would not have worked either. This poses two sorts of problems. Firstly if he has effectively cut interest-rates by 1% what was he doing cutting them by 0.1% in December? Secondly he is confessing that interest-rate cuts are unlikely to meet the inflation target. This sits very uncomfortably with this bit.

Overall, it’s clear that the impact of the APP on confidence, credit and the economy has been substantial.

Also let’s face it the sentence below is a description of what has not happened in the Euro area since its inception.

Confidence comes from every party fulfilling its mandate.

What is the real problem?

Mario is desperate to tell us that low inflation is a bad idea presumably hoping we will forget the other parts of his speech where it has helped the economy. But as we progress we get to the true issue and it is the worst four letter word in the economic landscape right now, debt.

For example, if euro area inflation were to undershoot our baseline by just 1 percentage point each year for the next five years, it would increase the private debt ratio by around 6 percentage points. That might not sound like a big figure. But, over five years, it’s equivalent to €700 billion in extra debt for firms and households at a time when we should be aiming to reduce debt.

So at the current speed that is nearly a years worth of QE or APP or more than it has done so far as the total is 530 billion Euros.

The banks

The subject of debt and the banks is an intertwined one of course. Mario Draghi assures us that things can only get better.

And thanks to the creation of the Single Supervisory Mechanism (SSM) and the comprehensive assessment of banks’ balance sheets, banks are actually stronger now than they were a few years ago. Capital ratios for euro area banks have risen from around 8% in 2007 to close to 14% today. In other words, the risks are currently falling, not rising.

This has already led to some discussion about the problems of Deutsche Bank whose share price fell by over 5% yesterday after previous falls. Also there is the problem of banking in Mario’s home country Italy where we see this so far today.



But apparently that is not a sign of instability.

What’s more, though low-interest rates can encourage risk-taking, there are no warning signs of serious financial instability.

Many might say look at home Mario as the subject analysed in the article linked to below was the hot topic on Bloomberg television this morning.

Yet in other areas there are opposite signs of trouble.

That’s not to say we don’t see pockets of exuberance, for example in some housing markets.

However in a complete reversal of economic history up to this point we will apparently see this.

And let me also add that if we did at some point see a generalised overheating in the economy, it’s never a problem for central banks to withdraw excess liquidity.

Never a problem?

A Space Oddity

Mario Draghi tells us that criticisms I have expressed are false.

Others warned that we were exposing ourselves to heavy losses from expanding our balance sheet and accepting lower-quality collateral. In fact we haven’t had a single loss.

He seems to have forgotten that by buying ever more so far he has enforced this by doubling down! The Greek debt either has gone to the ESM (European Stability Mechanism) or is on its way there and 60 billion Euros per month of other Euro area debt is being bought by him apparently for an ever longer period! How could he have a loss as he is preventing it?

Market problems

Yesterday and today have highlighted that the beneficial half-life of Open Mouth Operations for equity markets has shrunk. Mario had a go last Thursday and last night yet markets have fallen yesterday and today. Yet if we move to government bond markets we have seen more signs of safe haven buying. The two-year yield of Germany has fallen to -0.46% and the five-year yield to -0.24% which are both records. Just as a reminder this means that investors are paying to hold German sovereign debt and by a record amount which gives us a different song to the “things can only get better” of Mario Draghi.

There is also the issue of the Euro exchange rate which is not following the hints of President Draghi. He would like it to fall further but it has got rather becalmed in spite of his moves in December and his current hints teases and promises. Some of that is due to the weaker path of the UK Pound £ but the Euro has in general stopped falling.


President Draghi has lost himself in a land of confusion as he alternates between describing his policies as a success and a failure. If they are working so well why has he added more and then so quickly making even more promises. He has become like Agent Smith in The Matrix series of films. The monetary taps are open interest-rates have been slashed to negative territory and yet if we move from price to quantity there must be clear issues with how much Italian banks for example are willing to lend.

Yet if we step back we see that employment has risen and the Euro area is seeing economic growth which of course are interrelated. This is a clear improvement but if we look at the latest business surveys the famous quote from Muhammed Ali comes to mind “Is that all you’ve got (George)” as we note the extraordinary monetary effort.

The survey data are consistent with GDP rising at a steady quarterly rate of 0.3-0.4% at the start of the year.


12 thoughts on “The Open Mouth Operations of Mario Draghi have a shorter and shorter half-life

  1. Shaun, please would you help me understand Mario’s words you quote in your ‘What’s the problem’ section. He starts by saying lower inflation will lead to a higher private debt ratio (agreed) but then says that’s equivalent to extra debt. How so?

    Thanks for another excellent blog.

    • Hi Doubting Dick and thank you

      Mario Draghi is looking at the value of the debt in real terms and factoring in that a 1% lower rate of inflation raises the real level of the debt. However he is a little unclear with his 700 billion Euros statement because that is a nominal amount rather than a real one. Of course the debt has not changed excepting a few inflation linked debts but the cost of repaying it has risen.

  2. “…Employment is rising, up by over 2 million people compared with the trough in 2013…..”

    wasnt that the Syrian refugee contribution ?

    sorry dont mean to be the cynic


  3. “…. And let me also add that if we did at some point see a generalised overheating in the economy, it’s never a problem for central banks to withdraw excess liquidity…..”

    stifles laff….

    yah right on Mario , as if the Banks had little to with the pump up the volume on assets

    it was their main reason !! duh!! it wasnt excess QE , they just did think they did enough QE !

    and to think this is the “talent” we pay extra for ……..


    Mario , this is for you ….

    Don’t you love farce?
    My fault, I fear.
    I thought that you’d want what I want…
    Sorry, my dear!
    And where are the clowns
    Send in the clowns
    Don’t bother, Mario is here.

    Judy Collins
    Send In The Clowns

    • Hi Forbin

      I didn’t know it at the time but your song rather applied to Mark Carney’s testimony in front of the Treasury Select Committee. He was roughly handled (hints of the “unreliable boyfriend”) by the chairman on the issue of them going to a lot of trouble over wanting a 5 year term and then now changing his mind on it. Or maybe not as the Governor just waffled…..

      I love the way that virtually all central bankers say it is easy to take away excess liquidity as it has proved very troublesome in the past. But they have forgotten the lessons of macroprudential policy too…..

      As to your first comment wasn’t 2013 and 14 a bit early for any Syrian influence?

  4. The Euro exchange rate is a big headache for Mario and it appears to have learned once again to defy gravity. I would expect to see Eurozone growth start to stumble again if Euro strength continues. A friend who has a vineyard in northern Italy (good friend to have!) is suffering cancellation of orders for the UK as the sterling price has risen significantly in recent weeks. It must also reduce the spend of Brits on holiday although they always seem to find extra cash somehow. It could have a knock on effect in Portugal and Spain who depend so heavily upon tourist cash. On a slightly different subject, reports from friends in Greece are dire with no improvement at all just a steady decline. The pressure from the Troika on Greek pensions could be a catalyst for further unrest although exactly what the impact will be on Greek pensions appears to be a bit vague. Everyone I have spoken to expects further cuts and that might just be a cut too far. I have been surprised by how much pain the Greeks have been willing to endure so far but the Troika may yet push them over the edge.

    • Don’t they realize that this suffering is all in the cause of a better Europe? Suffering, poverty, decline; it’s all part of the greater purpose!

      • Evil comes in many guises and has called itself by many names, …

        still time for an Icelandic escape route for Greece ?


      • fabulous! his wines are called Peter Solva and are reasonably priced compared to better French wines. His Amistar red is very special indeed and i can recommend the De Silva Pinot Blanc crisp white. they all come from the Alto Adige region of Italy.

      • forgot to mention – there is a good interview with Varoufakis on Bloomberg. It rather confirms what I have thought for some time – Tsipras knows that the current strategy will fail but will go along with it because when it does it will be up to the EU / Troika to fix Greece after they have done all that has been asked of them.

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