Monday, April 20, 2009

ECB is totally behind the curve

Led by Trichet, the ECB remains to be behind the curve on all things monetary; but there is growing divide among the ECB governors:
Policy makers on the ECB’s 22-member council are divided over the best way to stem the euro region’s worst recession since World War II. Germany’s Axel Weber has ruled out cutting the ECB’s key interest rate below 1 percent and said he doesn’t want to buy debt securities. Greece’s George Provopoulos and Athanasios Orphanides of Cyprus want to keep open the option of deeper rate reductions and asset purchases to fight the risk of deflation.

Trichet said there was no split among the Governing Council. He declined to comment on any possible non-standard measures the bank may decide at its May 7 meeting.

We will have to wait until May 7 to see if the ECB will engage in QE policy. But don't hold your breath: if it took this long for the divide to surface, I imagine it will take longer to redefine the majority. Therefore, nothing of interest is likely to come on May 7 other than another 25 bps cut in its refi rate and likewise downward momentum in alternative policy rates.

The ECB is behind the times. The chart (above) illustrates annual real money supply growth through February 2009 in the U.K., the Eurozone, and Japan, and through March 2009 in the U.S. The ECB is facing a two-month decline in its annual real money growth rate. If this continues, the effects will be restrictive on the economy. Interestingly, the U.S. is still struggling against a falling historically low money multiplier amid its quantitative easing measures as its annual growth rate bounces around 9.5%-10%.

The 6-month annualized real money supply growth illustrates better recent monetary policy shifts (graph to right). Clearly, the U.K. and the U.S. are actively engaged in QE; and to a lesser degree, I believe that the Bank of Japan is as well. However, it is obvious that the ECB is not; its 6-month annualized growth rate is just barely breaking trend since January 2007.

And finally, nominal money growth in the first three months of 2009 paints a similarly dark picture for the Eurozone.

The U.K. and the ECB have not recorded their March aggregates yet, but the trend is likely to follow this one: the ECB is lagging, allowing its money supply growth rate to fall in spite of the February bounce. This is dangerous. Falling nominal money will eventually drop prices, even core prices.

Perhaps the ECB wants relative prices to change - all QE economy prices rise or at least fall less quickly compared to those in the Eurozone - in order to stimulate exports. I don't know, seems rather masochistic, don't you think?

Rebecca Wilder


  1. You could argue that the ECB is behind the curve, or then you could argue that the ECB is ahead of the curve. I bet on the ECB.

  2. "U.S. is still struggling against a falling money multiplier"....not anymore.

  3. Hi Flow5,

    You said, "not anymore."

    You are right. The multiplier (last time I checked) had stabilized at a historically low level. But it is still, nevertheless, low.


  4. You're of course right. But it's turned, and that portends a minor uptick in the rate-of-change in overall inflation, no matter how measured (gas prices are inching up).

    But most important, the powers that are attached to the FED's influence on the economy is always frequently exaggerated.

    It isn't within the power or responsibility of any Central Bank to hold unemployment or gross domestic product to “tolerable” levels.

    To assume that the Fed, ECB, Japan, UK, etc. can solve their/our unemployment problems is to assume the problem is so simple that its solution requires only, e.g., that the manager of the Open Market Account buy a sufficient quantity of eligible obligations for the accounts of the 12 Federal Reserve banks. This is utter naivete.

    The Board and most of the public apparently accept the dictum that high interest rates are prima facie evidence of a restrictive monetary policy and low rates are evidence of a loose monetary policy.

    If the time frame of your economic policy is 24 hours rather than 24 months, they are. For example , if the manager of the Open Market Account puts in buy orders for Treasury bills for the accounts of the 12 Federal Reserve banks, the prices of these bills will tend to rise, and their yields (interest rates) fall.

    This particular procedure, taken alone, would be evidence of an easier or less restrictive monetary policy. And the opposite action would be evidence of a tighter monetary policy. But, as noted, this is a 24-hour phenomenon.

    Over a period of time, open market operations of the buying type, because they provide legal reserves (an increase in lending capacity) to the banking system, result in an expansion of bank credit and thus an increase in the money supply.

    It is the excessive increase in the money supply combined with a rise in the transactions velocity of our money that is largely responsible for high rates of inflation.

    This in turn was almost wholly the cause of our past high interest rates, i.e., the 17 consecutive target federal fund rate increases.

    Unfortunately, the Federal Reserve doesn't gauge the volume and timing of its open market operations in terms of the amount and desired rate of increase of "free gratis" legal reserves, but rather in terms of the levels of the federal funds rates (the interest rates banks charge other banks on excess balances with the Federal Reserve).

    Since 1967 the federal funds rate has become virtually the sole criterion in the formulation and execution of open market policy.

    This policy is euphemistically referred to as accommodating the money market. It would be more accurate to characterize the policy as one that accommodates profligate bankers.

    The structural alterations in our money markets and the practices thereby engendered, led to a mélange of excessively destabilizing price changes, especially of those assets, real estate, etc., which serve as loan collateral. The whole brew of ill-advised deregulation and regulatory permissiveness fostered an atmosphere in which greed seemed to triumph, especially if a little fraud was diluted with a heavy dose of incompetent supervision by the authorities and their examiners.