Unconventional monetary policies pursued by the world’s biggest central banks in response to one of the biggest financial crises in history have come under criticism all over the place.ECB executive board member and French economist Benoît Cœuré gave a big speech today at the Institut d’Études Politiques in Paris on the evolution of the euro crisis and articulated the most severe issues facing the eurozone right now (from a financial standpoint), and he gave a forceful defence of the ECB’s new plan to fix them.
Arguably the most important part of the speech, though, was Cœuré’s assertion that it’s time for euro area leaders to follow the ECB’s lead with “passive” fiscal policy, while the central bank gets to work:
To borrow from Leeper’s terminology, this means that an “active” monetary policy – namely a monetary policy that actively engages in the setting of its policy interest rate instrument independently and in the exclusive pursuit of its objective of price stability – must be accompanied by “passive” fiscal policy. A passive fiscal policy means that the fiscal authority must be ready and willing to adjust its policy stance (revenues and primary spending) in such a way as to stabilise its debt at any level of the interest rate that the central bank may choose. Or, to put it another way, borrowing from Woodford’s terminology, fiscal policy needs to be “Ricardian”.
Cœuré used a series of charts as part of his presentation to explain how the ECB’s new plan aims to patch the fragmentation in euro area financial markets.
The ECB had to break open a new path to provide banks liquidity and keep the financial system from collapsing
Now, banks are financing themselves using bonds of much longer maturities than before to secure financing from the ECB – so the LTROs have delayed the bank funding problem for a while...
And with interest rates at record low levels, private sector companies are increasingly relying on debt to finance themselves
The freeze in interbank lending coincided with a massive selloff in government debt of weakened euro area countries
And this chart illustrates that conventional monetary policy has been effective in lowering rates for the strongest 20% of euro area banks (the ones in the core, mostly), but definitely not for the rest
OMTs are meant to equalise credit conditions across the euro area and not to ease general credit conditions – and since the market isn't expecting deflation, quantitative easing still isn't appropriate
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