Why ECB purchases could be more stimulative, euro for euro, than UK or US QE.

A short post substantiating my tweet yesterday asserting this, which was picked up by the Guardian, but, all on its own, to those not swimming in this stuff, might look rather odd.

We could think of an ECB purchase of a package of bank loans (an ABS) in two steps. First, it agrees to buy a government security from the bank. Then, in step 2, it agrees to swap this for an ABS issued/held by the bank. In reality, of course, the purchase involves a single step, a straight swap of electronic reserves for the ABS.

However, thinking of the purchases in two synthetic steps highlights why these purchases might be more stimulative than the Fed/BoE asset purchases, which involved straight swaps of reserves for gilts. [Leave aside the earlier Fed purchases of agency debt, and the tiny amounts of corporate paper the BoE bought]. Unless you think the swap stage would have no stimulating effect on the bank, or a negative effect, the ABS purchase must be more stimulative. If one supposes that the value of the government securities is effectively underpinned by Draghi’s earlier promise to invoke ‘Outright Monetary Transactions’ (OMTs), then we presume that the private bank and its funders feel its balance sheet to be less risky if it dispenses with an ABS than a government security. (In the past I blogged that I thought that OMTs were an almighty bluff and was puzzled that markets had not called it. They don’t look like calling it any time soon, so this presumption seems fine.) Wholesale debt funding can now be sourced more cheaply, its equity price will rise, and it will feel able to extend new loans at lower cost, stimulating spending by households and companies dependent on that funding.

Actions like this were urged on the Bank in the early days of the crisis, both publicly, by former MPC member Adam Posen, for example, but also privately, by myself and others on the staff, precisely on the grounds that one would presume them to have a larger bank for buck using this logic. In that case there was less of a question surrounding the credit-worthiness of gilts either, so the conclusion that private asset purchases would be more stimulative was on firmer ground.

This said, as I tweeted, though more stimulative euro for euro, one would presume that the purchases will be on a significantly smaller scale than US/UK QE.  [At least, assuming that there is no subsequent round of straight purchases of government securities].

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6 Responses to Why ECB purchases could be more stimulative, euro for euro, than UK or US QE.

  1. SVAR says:

    I would agree, but it is questionable, at least, whether balance sheet relief for banks is a monetary policy task. Especially, when the same institution has a responsibility for banking supervision and is scrutinising banks’ balance sheet in a comprehensive assessment exercise at the same time.

    • Tony Yates says:

      In an ideal world, I agree that this a weighty consideration. But with no other agency to do this in the EU, given the problems coordinating efforts across multiple fiscal agents, I’d say there was no choice. Could be addressed by consolidating a separate and integrated EZ supervisory agency.

      • SVAR says:

        If there are problems in coordinating fiscal agents, the answer in a democratic society can not be that it should be left to monetary policy technocrats to achieve the economically desired outcome. Moreover, one of the collateral damages of monetary policy acting as the cavallery on a sustained base, is that it will take away the political pressure that is needed to move foreward in setting up a consistent institutional framework in EMU

      • Tony Yates says:

        There I disagree. It’s the job of the central bank to do what it’s fiscal agents told it. If credit easing helps achieve its mandate, it should be done. Arguing that this is not desirable because it is not ‘monetary’ policy is theoretically dubious and futile [I wrote about this in a previous post], though topical, since the interactions between the German courts and the ECB have hinged on this language. Arguing that the central bank should try to deliberately under-achieve on its objective so as to make it more likely that the fiscal agents agree on better settings for their instruments seems to me not right, since the central bank was not mandated with the task of improving fiscal coordination. As a matter of realpolitik, one could think about such a strategy for the central bank. But it’s a costly one for a society, and might not work. For example, if the lack of coordination is not amenable to ‘monetary pressure’, the effort (cost paid in terms of lost output) would be waisted. And right now, with risks of being caught in a deflationary trap, trying deliberately looser policy is an extremely hazardous course of action. As you point out, there are risks associated with credit easing, but they are more than offset by the risks of inaction in my view.

  2. SVAR says:

    One might doubt that it is the job of an independent central bank to do what its fiscal agent tell it to do. But that is not the point in the euro area. Her, we have no democratically legitimised fiscal agent who could tell the ECB what to do. It is monetary policy who jumps into the fiscal policy arena (or at least into the grey area between monetary and fiscal policy) and stretches existing legal provisions to the extreme.

    You argue that this is legitimised when there is the risk of undershooting the stability target. This is an important argument. It certainly justifies a lot of conventional and unconventional policies. But put to the extreme, it would imply that unlimited risk transfer via the Eurosystem balance sheet would be justified as long as it can be argued to serve price stability. And one has to rmember, that in the euro area the threshold for price stability has been defined by the monetary policy experts themeselves.

    But in a way, all these issues have one underlying common theme: a montary union without a political union is a means to ask for constant trouble. I guess, we could converge to that view.

    • Tony Yates says:

      For the sake of argument, I’d state that the Treaty, agreed by the fiscal agents, and which instructs the ECB, who then interpreted its mandate for price stability, provides the route by which your fiscal agents told the ECB what to do. This is not unproblematic, as you rightly point out, because those instructions were quite vague. I would not suggest that unlimited risk transfers would be justified: however, I would suggest that on pragmatic grounds, very large transfers would be justified, as, if the ECB does not manage to avoid deflation, the chance that the Eurozone breaks up becomes much greater, and the chance of some speculative attack that makes this prophecy self-fulfilling more likely. Such a break-up would be extremely costly indeed. One can imagine an orderly separation between say North and South that might just be executed so that it is not too costly. But a disorderly break up is a risk worth avoiding with very substantial credit easing policies, in my view. I think this calculus would be true even if the German state were to take the narrowest possible economically self-interested view of the matter.

      I certainly agree with your final point, and it’s amazing that the Scottish National Party in the UK has not had more trouble over it, and has convinced many people that the UK are bluffing when they say that they will not offer a currency union.

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