ECB is running out of ammunition. What’s next?
There is a self-evident truth: if you want to make your economy grow, print some additional piles of money and buy government bonds. That’s what many banks did in previous years to save their national economies from tipping into devastating recession. For a while this strategy worked, economies gulped these pills and continued to run at their moderate pace. But it’s appeared that there is no panacea from stagnation. Even the full-blown QE ceased to spur economic growth.
And then, the Bank of Japan after careful examination of this problem invented another cure for its wrenching and staggering economy - long-term yield targeting. It may generate the inflation; banks will be able to make money by borrowing short-term funds cheaply and lending at higher rates over the longer terms; and insurance firms and pension funds will meet their long-term commitments. Everybody is happy; there is no need to deepen negative interest rates further. Whether this measure will actually work in the future, time will show.
The BoJ’s move attracted attention of its European homologue – the ECB straining every nerve to boost economic growth of its charges. At first glance, the BoJ’s innovative monetary tool would solve many of the European Central Bank’s problems, but whether it’s so, let’s figure it out. With the inflation hardly reaching the bank’s 2% target, the ECB will have to add additional stimulus to the struggling economies of the European countries. If the ECB decides to apply the Japanese yield targeting, it may run out of paper to buy in the EU biggest economies. That, in turn, may lead to growing discontent and mounting indignation from Germany and France.
Moreover, once the ECB adopts this new policy, it will have to violate the so-called capital key rule which requires the ECB to buy assets in accordance with the size of the euro zone economies. If this rule was altered, it would relieve banks from the need to buy German Bunds. They would be able to switch to the bonds of the heavily indebted states (Italy, for example). And this is inadmissible in given circumstances. So, could yield targeting program be an option for the ECB? – Big question mark. We just cannot rule this out yet.