The ECB now considers fiscal policy via QE to be its most effective economic weapon

Yesterday saw ECB President Christine Lagarde give a speech to the European Parliament and it was in some ways quite an extraordinary affair. Let me highlight with her opening salvo on the Euro area economy.

Euro area growth momentum has been slowing down since the start of 2018, largely on account of global uncertainties and weaker international trade. Moderating growth has also weakened pressure on prices, and inflation remains some distance below our medium-term aim.

In the circumstances that is quite an admittal of failure. After all the ECB has deployed negative interest-rates with the Deposit Rate most recently reduced to -0.5% and large quantities of QE bond buying. No amount of blaming Johnny Foreigner as Christine tries to do can cover up the fact that the switch to a more aggressive monetary policy stance around 2015 created what now seems a brief “Euro boom” but now back to slow and perhaps no growth.

But according to Christine the ECB has played a stormer.

 The ECB’s monetary policy since 2014 relies on four elements: a negative policy rate, asset purchases, forward guidance, and targeted lending operations. These measures have helped to preserve favourable lending conditions, support the resilience of the domestic economy and – most importantly in the recent period – shield the euro area economy from global headwinds.

It is hard not to laugh at the inclusion of forward guidance as a factor as let’s face it most will be unaware of it. Indeed some of those who do follow it ( mainstream economists) started last year suggesting there would be interest-rate increases in the Euro area before diving below the parapet. There seems to be something about them and the New Year because we saw optimistic forecasts this year too which have already crumbled in the face of an inconvenient reality. Moving on you may note the language of of “support” and “helped” has taken a bit of a step backwards.

Also as Christine has guided us to 2018 we get a slightly different message now to what her predecessor told us as this example from the June press conference highlights.

This moderation reflects a pull-back from the very high levels of growth in 2017, compounded by an increase in uncertainty and some temporary and supply-side factors at both the domestic and the global level, as well as weaker impetus from external trade.

As you can see he was worried about the domestic economy too and mentioned it first before global and trade influences. This distinction matters because as we will come too Christine is suggesting that monetary policy is not far off “maxxed out” as Mark Carney once put it.

For balance whilst there is some cherry picking going on below I welcome the improved labour market situation.

Our policy stimulus has supported economic growth, resulting in more jobs and higher wages for euro area citizens. Euro area unemployment, at 7.4%, is at its lowest level since May 2008. Wages increased at an average rate of 2.5% in the first three quarters of 2019, significantly above their long-term average.

Although it is hard not to note that the level of wages growth is worse than in the US and UK for example and the unemployment rate is much worse. You may note that the rate of wages growth being above average means it is for best that the ECB is not hitting its inflation target. Also we get “supported economic growth” rather than any numbers, can you guess why?

Debt Monetisation

You may recall that one of the original QE fears was that central banks would monetise government debt with the text book example being it buying government bonds when they were/are issued. This expands the money supply ( cash is paid for the bonds) leading to inflation and perhaps hyper-inflation and a lower exchange-rate.

What we have seen has turned out to be rather different as for example QE has led to much more asset price inflation ( bond, equity and house prices) than consumer price inflation. But a sentence in the Christine Lagarde speech hints at a powerful influence from what we have seen.

 Indeed, when interest rates are low, fiscal policy can be highly effective:

Actually she means bond yields and there are various examples of which in the circumstances this is pretty extraordinary.

Another record for Greece: 10 yr government bonds fall below 1% for the first time in history (from almost 4% a year ago)  ( @gusbaratta )

This is in response to this quoted by Amna last week.

 “If the situation continues to improve and based on the criteria we implement for all these purchases, I am relatively convinced that Greek bonds will be eligible as well.” Greek bonds are currently not eligible for purchase by the ECB since they are not yet rated as investment grade, one of the basic criteria of the ECB.

Can anybody think why Greek bonds are not investment grade? There is another contradiction here if we return to yesterday’s speech.

Other policy areas – notably fiscal and structural polices – also have to play their part. These policies can boost productivity growth and lift growth potential, thereby underpinning the effectiveness of our measures.

Because poor old Greece is supposed to be running a fiscal surplus due to its debt burden, so how can it take advantage of this? A similar if milder problem is faced by Italy which you may recall was told last year it could not indulge in fiscal policy.

The main target in President Lagarde’s sights is of course Germany. It has plenty of scope to expand fiscal policy as it has a surplus. It would in fact in many instances actually be paid to do so as it has a ten-year yield of -0.37% as I type this meaning real or inflation adjusted yields are heavily negative. In terms of economics 101 it should be rushing to take advantage of this except we see another example of economic incentives not achieving much at all as Germany seems mostly oblivious to this. There is an undercut as the German economy needs a boost right now. Although there is another issue as it got a lower exchange rate and lower interest-rates via Euro membership now if it uses fiscal policy and that struggles too, what’s left?

Mission Creep

If things are not going well then you need a distraction, preferably a grand one

We also have to gear up on climate change – and not only because we care as citizens of this world. Like digitalisation, climate change affects the context in which central banks operate. So we increasingly need to take these effects into account in central banks’ policies and operations.

Readers will disagree about climate change but one thing everyone should be able to agree on is that central bankers are completely ill equipped to deal with the issue.


This morning’s release from Eurostat was simultaneously eloquent and disappointing.

In December 2019 compared with November 2019, seasonally adjusted industrial production fell by 2.1% in the
euro area (EA19)……In December 2019 compared with December 2018, industrial production decreased by 4.1% in the euro area……The average industrial production for the year 2019, compared with 2018, fell by 1.7% in the euro area

The index is at 100.6 so we are nearly back to 2015 levels as it was set at 100 and we have the impact of the Corona Virus yet to come. Actually we can go further back is this is where we were in 2011. Another context is that the Euro area GDP growth reading of 0.1% will be put under pressure by this.

In a nutshell this is why the ECB President wants to discuss things other than monetary policy as even central bankers are being forced to discuss this.

 We are fully aware that the low interest rate environment has a bearing on savings income, asset valuation, risk-taking and house prices. And we are closely monitoring possible negative side effects to ensure they do not outweigh the positive impact of our measures on credit conditions, job creation and wage income.

But central bankers are creatures of habit so soon some will be calling for yet another interest-rate cut.

Let me finish with some humour.

Governors had to stop trashing policy decisions once taken and keep internal disputes out of the media, presenting a common external front, 11 sources — both critics and supporters of the ECB’s last, controversial stimulus package — told Reuters.

Yep, the ECB has leaked that there are no leaks….




9 thoughts on “The ECB now considers fiscal policy via QE to be its most effective economic weapon

  1. Hello Shaun,

    The CBers have been mooting fiscal policy for some time now – but of course they cannot admit to their QE as a failing exercise can they ?


    • Hi Forbin

      I think this is more a case of c*ck up than conspiracy but it has turned out to be convenient for both central banks and governments. The central bank can remit QE profits to the government and thus its own salary bill tends to be nodded thorough. Governments get both a dividend and much cheaper borrowing costs.

      So “independent” central banks are here to stay….

  2. Great blog as usual, Shaun.
    At least Madame Lagarde did not make any references to helicopter money drops in her speech. Carolyn Wilkins the Senior Deputy Governor of the Bank of Canada, spoke in Toronto last Wednesday. After lying low during the election period from talking up a higher target rate of inflation she is back at it again, this time pushing forward, without attribution, the ideas of the former deputy governor of the Bank of Canada, Jean Boivin. Madame Lagarde’s speech stressed the role of an expansionary fiscal policy in helping the euro area. Helicopter money blurs the distinction between monetary policy and fiscal policy. As is its wont, the Bank of Canada bases its comments on a “forthcoming” staff paper, namely “The Power of Helicopter Money Revisited: A New Keynesian Perspective”, which still hasn’t been released a week later, and may, given the BoC’s track record, never be released. Dave Parkinson of the Globe and Mail, wrote of Wilkins’s speech: “The bank will look at the effects of balancing periods of below-target inflation by temporarily aiming for above-target inflation, and vice versa; using nominal gross domestic product as a target rather than inflation; and adopting a dual mandate of both an inflation target and full employment…” There is no reference to helicopter money drops in Dave’s summary although it was highlighted in Wilkins’s speech. Also the vice-versa reference, which was taken verbatim from Wilkins’s speech, is a tad suspect. The helicopter money drop paper by Jean Boivin and colleagues only spoke of price level targeting, since that is really what is under discussion, in connection with the helicopter money drops, to react to a recession. Once you change your regime from inflation targeting to price level targeting in a recession there is nothing to prevent you from switching back again in an expansion. Rinse and repeat. It is really another way to guarantee the public a more inflationary future over the long term.
    There seem to be a lot of central bankers musing about a target rate of inflation above two percent, but no-one, neither Lagarde, Powell, nor anyone else, who want to take it lower. It’s a shame. As John Crow wrote in “Canada’s Difficult Experience in Reducing Inflation”: “[A]t no point did the Bank volunteer a numerical price-stability target – although early on I did, in response to a media question, indicate that as regards a desirable rate of inflation, ‘three is better than four, two better than three, one better than two, and zero better than any of them’.” I’m looking forward to Mme Lagarde’s dynamite “one is better than two” speech. When will it happen?

    • er ” I’m looking forward to Mme Lagarde’s dynamite “one is better than two” speech. When will it happen?…”

      would you trust what this woman said anyway ?


      • ” Like digitalisation, climate change affects the context in which central banks operate.”

        I wouldn’t trust her to administer digitalis.

      • Thank you for your response, Forbin. No, I don’t trust much that Mme Lagarde said, and in the unlikely event she came out in favour of a one-percent target rate of inflation, I would be skeptical about her implemnting it.
        By the way, my search engine let me down in my comment. The forthcoming paper by Thomas Carter and Rhys Mendes on helicopter money is available online now and seems to have been posted on February 10. In this instance, at least, my snide comment about the Bank of Canada was unwarranted.
        I glanced over the paper quickly. There was no reference at all to the paper by former deputy governor Jean Boivin and others, although it obviously seems to have inspired this effort. That paper combined the ideas of using helicopter money and a price level targeting regime in an economic downturn. The paper by Carter et al is generally negative about helicopter money but much more positive in the on-the-one-hand-on-the-other-hand economist style towards price level targeting (PLT). If one takes it as an indication of where the Bank of Canada is headed, it would mean that the dystopian vision I had of our central bank planning to take us into hyperinflation through helicopter drops of money was wide of the mark, but the idea of them moving to PLT to jack up inflation is still very much an option, if not an undeclared plan. (Incidentally, the Canadian inflation rate has been 2.2% since November 2019; the Bank of Canada is the the only central bank in the G7 that is exceeding its inflation target.)

      • Forbin, just for clarification, while Senior Deputy Governor Wilkins’s paper makes no direct reference to the paper by Boivin et al, on helicopter drops the forthcoming paper she references by Bank of Canada staffers does: as a paper by Bartsch et al. You have to go to the reference list to see that a former Bank of Canada deputy governor, widely spoken of as a candidate to be the next governor, was one of the co-authors of the paper in question. I would have thought that Bank of Canada staffers would be a little more collegial than that, but perhaps they are just following the stylistic conventions for Bank of Canada discussion papers.

  3. Hi Shaun

    The use of fiscal policy when rates are low and monetary policy seems to have reached its limits seems very sensible. There’s a problem however as I see it: the Stability and Growth Pact.

    You will recall that this limits deficits to 3% and debt/ gdp ratios to 60%. The EU has listed eight countries with actual or potential deficits which could exceed the 3% level. Furthermore the 3% is not subject to cyclical adjustment and what this could mean in the face of a significant downturn is that far more than eight countries may be subject to a breach merely when the automatic stabilisers kick in never mind any discretionary spending.

    There’s no doubt that some fiscal spending could be carried out without an egregious breach of the SGP but this may be far less than what may be required to take any effective macroeconomic action. The pact robs countries of what many would deem necessary flexibility in managing economies.

    In any case, even without the strictures of the SGP the expansion of debt ratios to GDP in the EZ simply stores up more problems for the future. The Euro is full of prescriptive rules that have driven divergence instead of convergence with all the surpluses being in the North and all the deficits being in the South. What is needed is to complete the architecture of EMU but the more economies diverge and the more they are deprived of the necessary tools of flexibility the more difficult that resolution becomes and the more unsustainable is the whole project. Lagarde may sound halfway sensible in suggesting a fiscal boost but looking at the Euro as a whole there is a studious ignoring of the elephants in the room.

    • Hi Bob J

      You comment reminds me that the SGP is something that has survived in spite of criticism and the fact it was ignored by some for a while. We heard quite a bit of rhetoric from Mario Draghi about the ECB being a “rules-based organisation” but when they decided they did not like a rule they simply changed it. But the SGP has survived and is being implemented in terms of fiscal deficits ironically at a time when more than a few Euro members could not only afford to spend more but have economies which need it as you say.

      Moving to debt then in places like Greece and Italy some of it will have to be written off and there seems to be no stomach for that at all.

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