by Andreas Hoffmann*
The European Central Bank (ECB) and the Fed differ in many aspects. First, the ECB is considered to be more hawkish on fighting inflationary tendencies. Its primary goal is price stability and it has continued to watch money growth. Output gaps below full-employment are only considered secondary as instrument to forecast inflation.
Secondly the ECB was constructed to be more independent than the Fed. Thus there has been less interaction with fiscal authorities. Less mobility from governments to the ECB (and vice versa) documents this independence. While in the US it is common to see central bank officials and the secretary of treasury plan the future of the economy, in Europe this is not the case. Central bank independence is considered an important aspect of credibility and stability of the currency (the German central bank model). However, the current crisis has made the ECB more “Anglo-Saxon.”
Recently the ECB has announced to buy government bonds of crisis countries. This should help pushing down risk premia of bonds to a “normal” level (wherever this could be) to allow these countries to cope with consolidation and austerity plans. For the first time the ECB has followed Anglo-Saxon central bank policies to stabilize markets, because other solutions to the problems – such as defaults and insolvencies – have no political support.
The Fed bought 5 % of the treasuries and more than 10 % of the mortgages in the latest crisis. A similar policy is likely to prevent a spill-over of the debt crisis from Greece to Portugal and may depress speculation against the euro. If this does not help, the ECB could monetize the debt completely. Therefore signaling that the ECB will do everything to keep countries solvent may contribute to stability (in the short-run).
In the long run, inflation expectations could rise. However, the ECB promises to watch money growth and sterilize bond purchases to not fuel inflation. There are at least three ways to sterilize: First, it could absorb surplus liquidity from last year’s 12 month tender in June, which could account for 442 billion euro or 600 billion dollars (link) Second, the ECB could go over to fine tuning measures and absorb liquidity here and there. And third, the ECB could sell debt securities to banks to take liquidity out of the system.
But currently the ECB does not even have control over money supply as it fully serves money demand of the banking sector through full allotment fixed rate tender operations, in which banks can ask for any amount of liquidity at a fixed interest rate. Further additional tenders (due to the crisis) rather increase money supply. Banks even store deposits at the central bank.
If the ECB takes money out of the system, these low-yielding deposits may shrink (which are being build up currently to have liquidity when the ECB starts absorbing), but not necessarily the money in the economy. Thus sterilization may not be successful right away. It is also not very likely in the midst of crisis due to two reasons: First, the latest fall in the euro does nothing but help the euro area’s periphery countries to regain some competitiveness and supports their recovery. Second, prices are levels are stable and a second recession could actually have deflationary consequences in some areas. Thus it is going to be interesting to watch the near future wording of ECB statements. I believe they are likely to change from addressing the issues of money growth to price level stabilization as it is done in the US.
If sterilization works, the ECB may remain credible and could possibly point to this as a one-time bail-out. But even this is problematic as with the introduction of the “transfer union” countries with thriving deficits will expect to be bailed-out. Thus the independence of the ECB from fiscal policy making is in danger. If this last bastion falls, the transformation of the ECB to an Anglo-Saxon style central bank will be completed. France and other countries have been pushing for this for a long time.
*Andreas Hoffmann is a doctoral candidate at the University of Leipzig and currently visiting the Department of Economics at New York University