Time to couple or decouple from the Fed ….
The Fed’s stated intentions and capabilities to taper, at the Jackson Hole symposium, set the agenda for the ECB’s September Governing Council meeting. If the ECB were to define its role and distinguish its new monetary policy framework from the Fed, this was the time.
There may be a cure for the Summertime Blues ….
The ECB went on holiday with no clear consensus on how to overshoot its new symmetrical inflation target. The Delta and Mu variants and declining inflation pressures may help the central bankers to make up their minds on return.
With the Eurozone economic headwinds strengthening, and the Jackson Hole Summit just around the corner, ECB Chief Economist Philip Lane broke out of holiday mode, early, to start nudging policy perceptions for the remainder of the year. Apparently, “favorable financing conditions”, as defined by M3, aren’t getting any more favorable. Admittedly, the current M3 numbers have tough historical comparisons, on an annual basis, because this time last year the ECB was heavily engaged in emergency stimulus. Core CPI remains subdued. Historical comparisons, for Core CPI, suggest that despite the current headlines the Eurozone remains disinflationary prone first and foremost. There is, thus, a case to be made for further monetary policy easing, although Lane is not making it yet. The case for maintaining the current monetary policy stimulus is firmly supported.
The money supply situation is, however, nuanced.
Eurozone households continue to have “favorable financing conditions”.
Whereas, non-financial institutions are having less “favorable financing conditions”.
Financing conditions, in the form of deposits, are definitely unfavorable for the banks. Negative interest rates are not favored by depositors. Without access to commercial “favorable financing conditions”, courtesy of the ECB, the banks would be constrained.
ECB bank supervisory chief Andrea Enria expects things to get worse, for the banking sector, before they get better. Currently, he envisages further pandemic-related deterioration on the quality of the banks’ asset books. In such circumstances, the banks will not be in a place to boost new credit creation without raising new equity capital, which they are unlikely to do. Consequently, the creation of “favorable financing conditions” remains heavily reliant upon ECB beneficence.
Lane is not calling for more monetary policy easing, yet, to deal with the strengthening headwinds. Instead, he is calling for robust extended forward guidance, in support of the new symmetrical monetary policy targeting framework, to raise inflation expectations as inflation itself begins to fall.
Lane’s latest guidance was consistent with his summation, in the recently released record of the last Governing Council meeting. Lane is on record, at the meeting, for saying that, “in implementing the new monetary policy strategy, it was important to update the Governing Council’s forward guidance on the key ECB interest rates. A commitment to maintain monetary accommodation on a persistent basis was essential in view of the effective lower bound constraint and the shortfall in the medium-term inflation outlook relative to the two percent target”. His recent guidance restates this position almost verbatim.
The record of the meeting also found a general agreement that the Eurozone economic recovery was proceeding, and that inflation was both a headwind and transitory in nature. There was an acceptance that current easy monetary policy settings should continue. The disagreement came in the wording of the conditions precedent to taper. The Northern European contingent wanted some rules-based contingency in place, whereas, the rest wanted a less specific assurance in principle.
As all central bankers, know by now, credible commitment in forward guidance can only be achieved through supporting monetary policy actions. Lane has, therefore, casually opened the debate around further monetary policy easing; even though his current objective appears to be to require looser for longer monetary policy settings. Looser for longer may, thus, in time, morph into even looser for even longer. This will, however, be firmly resisted by those Governing Council members who want some binding conditions attached to ending the period of monetary policy stimulus.
Lane remained elusive, if not exactly aloof, until the recent Governing Council meeting. In a pre-meeting probing, and oftentimes leading, interview he avoided the traps set by his interrogators. Whilst downplaying the significance of the current inflation and inflation expectations spikes, he refused to be drawn into concluding that this will oblige the ECB to ease again in September. Neither was he forthcoming on when the emergency stimulus would end, or what kinds of flexibility would be translated from the expiring temporary stimulus programs into the remaining longer-term ones.
Lane was, however, unequivocal that the ECB will not follow the Fed in tapering in the near term. On the contrary, should the Fed create a global taper tantrum Lane has implied that the ECB may actually respond by easing further.
The Northern European contingent, on the ECB Governing Council, has responded with alacrity to Lane’s prompting.
Klaas Knot is cautiously optimistic that growth and inflation are now on paths that justify an ending of the pandemic emergency monetary policy stimulus.
Robert Holzmann believed that the ending of the emergency monetary policy stimulus should have been discussed at the September Governing Council meeting, with a view to tapering monetary policy sooner than is currently anticipated by capital markets. Holzmann also believes that the adoption of the flexibility in the emergency short-term program should not be adopted into the existing long-term monetary policy easing programs. In fairness, Holzmann is hardly the Hawk. He willingly concedes that inflation will fall again, in time. All that he asks for, now, is an agreement to end the emergency pandemic stimulus next year, not even this year, because the vaccination rate is improving and each virus mutation has diminishing potency.
Bundesbank President Jens Weidmann has joined the Northern confederation; and warned that the ECB should not simply discount the threat of higher inflation as a default position.
The Northern European militancy within the ECB should, perhaps, be viewed as a reaction to the militancy of Lagarde’s perceived zeal for making the new symmetrical inflation target an enabler of permanently loose monetary policy. All that her detractors want, in principle, are some rules and conditions placed upon the reversal of monetary easing. Currently, they face a risk of the temporary stimulus flexibility being written into the longer-term monetary policy easing programs. For them, this is the antithesis of credible commitment to having a symmetrical inflation target. It is a commitment to deliberate target overshooting. Their resistance should, thus, be accepted and accommodated into some arcane guidance language that Lagarde can turn to her advantage when the right conditions prevail to do so. The Northern Europeans are, therefore, an irritant rather than a real impediment for Lagarde.
Governing Council member Francois Villeroy de Galhau has advanced to contact with the Northern European dissenters cautiously. Villeroy comes at the argument from the conclusion, that he wants, to frame the current conditions which vitiate against it. He frames the current inflation issue as a structurally logistic one, rather than a monetary policy one. He also frames this issue as transitory, whilst admittedly irritating in its current longevity. Consequently, there is nothing that monetary policy should do to address this matter. Despite the obvious economic headwinds, from blocked supply chains, even Villeroy accepts that emergency monetary policy stimulus must come to an end.
ECB Vice President Luis de Guindos also adopted a conciliatory approach to the upcoming debate at the next Governing Council meeting. He willingly conceded that growth and inflation are higher than previously expected. He, therefore, expected in advance that the ECB’s staff forecasts for both to be revised higher; which they were. He is even willing to further investigate whether there are tangible signs of second-round inflation pass-through effects. Evidently, De Guindos wants a monetary policy compromise, with the Hawks, and is willing to show wiggle room whenever needed.
De Guindos handicapped the central bank’s soon-to-be-released economic forecasts as highly likely to show further improvement, which they did. He did not, however, say that such an eventuality would lead to a significant change in current monetary policy settings.
Much ado about nothing ….
In the end, the pre-meeting kerfuffle between the Doves and Hawks on the Governing Council turned into nothing at the meeting itself. Business-like would be a good way to describe the latest meeting. There was a unanimous consensus to scale back monthly QE purchases without reducing the total size of purchases. Interest rates were left unchanged. Christine Lagarde then followed the decision announcement with a prosaic press conference statement. On the one hand, the economic recovery and vaccination program is in place. On the other hand, inflation is transient. The Eurozone economy still needs applied “favorable financing conditions”. Staff macroeconomic projections were revised higher for the short-term, but for the long-term growth and inflation are still challenged.
The Hawks can, thus, believe that this is the signal and prelude to tapering. The Doves can also believe that easing has been extended in duration.
Talking up the Eurozone economy suits both the Doves and the Hawks. There are tangible signs that the global economy is slowing. This global slowdown is in none of their interests, so bigging up the Eurozone growth story and incrementally moving the monetary policy furniture placings around accordingly, without tightening, is an expedient compromise. In the fullness of time, when economic gravity fully asserts itself, both factions can rearrange the furniture for a bias towards easing again.
Expanding the Public Liquidity Insurance Regulatory Footprint ….
(Source: the Author)
This author has been following the mission creep of the ECB into the role of a Public Liquidity Insurer. This new role is consistent with the ECB’s famous “favorable financing conditions” mantra throughout the pandemic. It is also synonymous with the monetary policy role in a foreseen future of Modern Monetary Theory. If ever there was a time, for Public Liquidity Insurance, now would be it. With inflation, allegedly, peaking and the money supply headed lower, some liquidity insurance would be well received.
ECB Executive Board member Isabel Schnabel recently confirmed that the mission creep has not been on hold during the summer vacation. Indeed, it had accelerated into the Jackson Hole central banker symposium. On the eve of the summit, Schnabel revealed more. She appeared to set her modest desires on garnering more financial stability policymaking power and regulatory turf for the ECB.
Schnabel has noted that, whilst small in comparison to the banking sector, the Eurozone’s shadow lenders have become an integral part in the creation of “favorable financing conditions”. Whilst she welcomes their participation, she also notes that the new financial stability risks, that they bring, must come under the ECB’s purview and regulatory regime. Cryptocurrency firms and exchanges will already know the feeling. Now it will be felt by shadow lenders and Fintechs.
Ironically, the ECB’s mission creep from central bank to public liquidity insurer may be driven by the fiscally and monetary policy austere Northern Europeans. Austria, at the helm of this movement, is animatedly nudging for a cut back in fiscal stimulus programs as the COVID vaccination program rolls out across the Eurozone. If Austria is successful, at the EU level, then a fiscal headwind will develop, thus, prompting the ECB to raise its game of public liquidity ensuring that “favorable financing conditions” prevail. There are initial signs of success for Austria with France, although this may be the Austrians unwittingly playing into French hands. French Finance Minister Bruno Le Maire has announced that emergency fiscal support for companies will be removed at the end of September. France is, ostensibly, on board with austerity. But is it really?
The prospect of coordinated fiscal stimulus removal, across the Eurozone, will inevitably blow back onto the ECB’s taper schedule. Hence, although French ECB Governing Council member Francois Villeroy de Galhau accepts the need to also remove emergency monetary policy stimulus, a simultaneous withdrawal of fiscal stimulus may limit the central bank’s tapering ambitions and scope. There is a growing pattern to the seeming French madness.
Austerity pas ….
If there appears to be sincere concord on monetary policy settings at the ECB, the same cannot be said of fiscal policy settings at the EU. Discord is looming in the fiscal arena. Disparate national economic strategies, to come out of the pandemic, lack coordination, and consistency at the EU level. EU deficit limits have been breached, and the nations involved are seeking uniquely national solutions to growth, which threaten to make the deficit situations even worse. French exceptionalism is taking the lead in remodeling the fiscal and reciprocal monetary policy landscape, thereby, setting dangerous precedents for the Northern Europeans.
Finance Minister Bruno Le Maire has hinted strongly that there will not be inflationary wage increases, in France, in general, with notable exceptions for those who have fallen so far behind during the pandemic. French fiscal coffers, allegedly, cannot afford generous pay rises. Private sector coffers may be able to, however, but will fight against pay rises tooth-and-nail. Consequently, the risk of second-round inflation risks is being interdicted structurally. This structural interdiction, by default, reverts the French economy back to the historic disinflationary modality of the Eurozone labor market. If this reversion occurs, monetary policy will have to remain looser for longer to counteract the disinflation.
But, then, seemingly, in contradiction, Le Maire has proposed a French budget devoid of tax increases but full of investment spending. The current fiscal deficit will, thus, balloon further. With low wages in prospect, the chance of any income tax revenues to finance the deficit look impossible in theory. As the reader will note later, Greece is of the same mind as Le Maire. So, France is becoming Greek and hopes that the Eurozone will follow. This fiscal style drift looks suspiciously like the fiscal component of Modern Monetary Theory.
(Source: @BrunoLeMaire, caption by the Author)
So, just as disinflation threatens to compress French bond yields, deficit spending nudges them higher. How is any of this sustainable? The short answer is “favorable financing conditions”. The ECB’s public liquidity insurance mandate will, thus, expand, to monetizing ballooning fiscal deficits. The combination of said deficits and monetary policy easing is conventionally known as Modern Monetary Theory (MMT).
It could be said that the French are trying to engineer Modern Monetary Policy in the Eurozone by fiat that then becomes EU diktat. German resistance, and leadership, have diminished as the curtain falls on Angela Merkel’s career. Germany may even be drifting towards France, politically speaking, on its current election campaign.
Other Eurozone nations are following France’s low-wage pandemic exit, although they have yet to couple this with fiscal expansion.
Not too dissimilarly, to France, Spain is considering only allowing the raising of the minimum wage.
EU economy commissioner Paulo Gentiloni, clearly, is worried about the potential drift back towards the disinflationary mode. He has warned the ECB against being trigger-happy with a premature tightening of monetary policy.
The EU’s own draft fiscal plan is long on vagueness and short on details. It would like to stimulate investment and also reduce fiscal deficits, simultaneously. These broad aims will find consensus in principle but no consensus on details.
So, fiscal stimulus in some form is guaranteed. What of the monetary policy expansion, that will complement it, under the Modern Monetary Theory heading?
(Source: ECB, caption by the Author)
Evidently, the ECB forecasters have not factored in Bruno Le Maire’s extended forward fiscal guidance, and also have not looked at what is going on in Greece right now.
Beware of Greeks dressing windows ….
Greece is plowing a uniquely fiscally dissonant farrow, as usual, that may well end in tears again. The nation is proud of its current Eurozone pace leading economic growth. Greek policymakers equate this growth with an inherently stronger tax base that will allow them to cut taxes even further. No hint of fiscal austerity or intentions and capabilities to pay for the COVID emergency stimulus. The Stability Pact theme of counter-cyclical fiscal buffer building, during times of growth, for that rainy day, is a casualty of COVID-19. Other nations, like France, and Spain, and Italy may have forgotten Grexit and may be keen to follow the Greek example.
Greek precedent-setting is not only limited to fiscal policy. The Greek banking system is also blazing a trail for other nations to follow. Indeed, Eurozone policymakers may be using the Greek banking system as a laboratory to test new economic policies.
(Source: the Author)
The last report discussed Plan C for the Eurozone banking system. Plans for banking sector consolidation have, apparently, been shelved in this new plan. The new plan is a sweet deal for private equity and bank shareholders. This new plan involves banks selling off assets, to private equity, and realizing losses; whilst evading either bail-ins of bank shareholders or bailouts from their governments that dilute their shareholders. The plan is being trialed in Greece. Presumably, if successful it will be scaled up across the Eurozone. This plan may not make it to France, however, and, hence, the Eurozone by default. Bank of France Governor Francois Villeroy de Galhau is not, currently, buying into Plan C. Instead, he is pushing to restart Plan A, that is to say, banking consolidation with France amongst the largest consolidators.
Modern Monetary Theory, in the Eurozone, may, however, have found a more powerful enabler than French and Greek grand strategy.
You can have frites with your MMT Fritz, but not chips ….
It will be interesting to see how the various factions in the EU, and the ECB, cope with the current supply constraints in the semiconductor sector. The auto manufacturers are already cutting production and raising prices. How this plays out will be a guide to how the current wave of Stagflation breaks across and then flows throughout the Eurozone economy. Ominously, the CEO of Mercedes has warned that the bottleneck conditions will persist throughout 2022. This time estimate is auspiciously concurrent with the time envisaged for the ECB to start tapering monetary policy. This may not be a coincidence.
Microprocessors are ubiquitous, so this structural headwind will spread rapidly and pervasively, thereby, calling for a coordinated fiscal and monetary policy response. Idled workers, waiting for the microprocessors to arrive, will need to survive; even if they aren’t doing a day’s work for their day’s pay. The viral conditions precedent, in this chip shortage, are similar to those that prevailed in the COVID-19 pandemic.