Despite the worst eurozone recession since the Second World War, M. Trichet seems determined to resist the zero interest-rate policy being pursued by just about everyone else, and continues to insist that, since nobody knows what the future will bring, it would be dangerous to go much further than he already has. The ECB's stance seems curiously out of sync with the derring-do of the G20.
M. Trichet justifies this stance on two fronts. The first is a little technical and also largely irrelevant. Once interest rates reach zero, the "transmission mechanism" whereby changes in monetary policy impact on the real economy breaks down. M. Trichet refers mysteriously to the dangers of a "liquidity trap" without really explaining what he means. But in any case, does it really matter when the economy is plunging into the abyss? There comes a point when rate cuts lose their economic traction and become merely a symbolic way of boosting confidence. The eurozone must surely be at or beyond that point.
The second reason at least has the merit of being comprehensible. M. Trichet acknowledges that there are plenty of "disinflationary" pressures around, but simply doesn't believe there is any danger of outright "deflation". Despite this repudiation of the deflationary threat, he nevertheless believes the time is right to consider "non-standard measures". Does that mean the ECB is going to follow others into expanding the money supply via "quantitative easing"?
Again, the ECB won't say. At yesterday's press conference, M. Trichet seemed to suggest that he may mean no more than further action on "enhanced credit support". The structure of eurozone finance is significantly different from the US and Britain, with a much bigger role for banks as opposed to credit markets. So rather than buying up government and corporate bonds in order to boost the money supply and ease credit conditions, as other central banks have, the ECB has been providing banks directly with the liquidity support they need to lend more freely.
There are big practical problems for the ECB in going the US and British route to QE. Which government bonds among the eurozone's 16 member states should it buy, and, if it is to purchase corporate bonds, which sectors and geographies should it target? What's more, who would guarantee the ECB against any losses sustained? Neither of these problems is insurmountable – on both counts, it could be done by reference to the relative size of each member state's GDP – but they would require a complicated renegotiation of the ECB's remit and modus operandi.
In any case, confusion reigns as to what the ECB might do next. Let's hope M. Trichet is right and that by the end of the year the eurozone will be recovering. If he isn't, then the ECB seems to be as clueless as everybody else as to what it is going to do about it.Reuse content