Christine Lagarde Can Face Down the ECB Skeptics

(Bloomberg Opinion) -- Christine Lagarde has taken the helm of the European Central Bank at a time of rising skepticism over the power of monetary policy. Critics say that the central bank has no tools left to bring inflation back to its target of close to, but below, 2%. The ECB is now a helpless bystander, they claim, as the power to foster a recovery sits squarely with elected governments.

There is little doubt that as the central bank digs deeper into its toolkit, some of its policies risk becoming less effective. But there is plenty more the ECB can do, from further rate cuts to more flexible asset purchases. And while the question over what to do next is largely political, Lagarde’s efforts to listen before she leaps and address tensions within the governing council head-on should provide a clean slate from which to take any difficult decisions down the road.

The defeatist case against the ECB starts from how far the central bank has already gone. In September, it cut the deposit rate to -0.5% and restarted net asset purchases. For some, that means the central bank can’t cut rates further without harming the economy. What’s more, within roughly a year, the ECB could hit its own self-imposed limits on its program of quantitative easing. 

Of course, the more the central bank presses on the monetary accelerator, the harder it is for its measures to push up the inflation rate and stimulate growth. But economists at the ECB still have tools they can use. For a start, they know they can lower the deposit rate further. An ECB working paper has shown that negative rates have not dissuaded savers from storing their money in a bank. Moreover, when banks have passed sub-zero rates on to corporations, it’s sparked them to increase their investment — which is the point of the policy. There are legitimate concerns over risks to financial stability, but these can be addressed via other levers, including higher loan-to-value ratios. 

The concerns over quantitative easing are also overblown. The ECB has decided it will purchase bonds according to each country’s shareholding in the central bank and will not hold more than a third of any euro-zone country’s sovereign debt. As Germany's public debt shrinks, and the central bank purchases more securities, the limit of how many bunds it can hold risks becoming binding soon. But the ECB has shown itself to be flexible in the past in terms of how precisely it needs to stick to some of these self-imposed constraints. In extremis, the governing council could scrap these ceilings and replace them with more generous ones. 

Finally, there are other, more extravagant avenues the ECB could explore, which would take it closer to fiscal policy. Mario Draghi, Lagarde’s predecessor, described the constraints of any intervention in his departing speech. “The euro area is built on the principle of `monetary dominance,’” he said. “Monetary dominance does not preclude communicating with governments when it is clear that mutually aligned policies would deliver a faster return to price stability. It means that alignment between policies, where needed, must serve the objectives of monetary stability,” he added.

The question is how far Lagarde will want to push against the resistance from her fellow central bankers. She inherited a deeply split governing council, so much so that she make her first meeting an off-site retreat to try and heal the fractures. Some policy makers, including the heads of the national central banks of Germany, the Netherlands and France, voted against Draghi’s decision to reactivate QE. Ignazio Visco, the governor of the Bank of Italy, has raised doubts over the prudence of cutting rates further in the future. Any more creative policies, bordering on fiscal policy, would no doubt meet opposition from the Bundesbank, which is terrified of any whiff of monetary financing of government debt. 

Since becoming ECB president at the start of November, Lagarde has not yet expressed any views on the future of monetary policy, but is expected to do so on Friday. How far the central bank needs to go will of course depend on the strength of the euro-zone economy, which is showing some early signs of stabilization after a terrible year. Yet, if further action is needed, the limits to what the ECB can do are largely political. It will be up to the new president to decide how far to go, and then rally the members of her governing council, even the most recalcitrant ones, to back the best path to get there.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Ferdinando Giugliano writes columns on European economics for Bloomberg Opinion. He is also an economics columnist for La Repubblica and was a member of the editorial board of the Financial Times.

©2019 Bloomberg L.P.

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