Having been upstaged again last week by the Federal Reserve, the European Central Bank will join its U.S. counterpart in the global economic spotlight when the Governing Council meets Thursday in Frankfurt and, like the Fed, signals further monetary stimulus ahead. But the ECB is facing a much more difficult script than the Fed. Lacking a more substantial role, the council’s performance likely will be driven by “active inertia,” appearing to be active and responsive but ending up simply repeating what it has done on many prior occasions: that is, more of the same despite growing evidence of its limited impact.

Let’s start with the six reasons the ECB’s task is so much trickier than that of the Fed (which doesn’t have an easy task ahead of it, either):

- The European economy has been slowing for the last year, led by perennial powerhouse Germany, whose economy is facing a widening gap between more buoyant domestic activities — construction and other non-tradables — and sectors hit by lower global demand. This all comes at a time when investment and consumption in Europe are less sensitive to liquidity stimulus, especially with financial conditions being so loose.

- Policy interest rates are already negative, raising concerns about unfavorable implications: promoting inefficient financial intermediation, distorting asset allocation, weakening more banks, and creating a less hospitable environment for consumers’ long-term financial-protection products such as life insurance and retirement.

- The stock of bonds eligible for purchase by the ECB has been diminishing, causing headaches not just for the central bank but also for others — institutions and markets — that are being affected by a shortage of risk-free assets. Simply expanding the ECB’s universe of allowable instruments is far from simple, and not just for economic reasons. It also entails increasing political risks.

- The scope for moral hazard increases as additional ECB stimulus takes pressure off other policy-making entities in Europe while encouraging market participants to take on even more risk.

- Further loosening of monetary policy increases the risk that Europe will be seen as aiming for an unfair currency-competitive position in order to maintain what already is a notable current-account surplus, thereby increasing the probability of U.S. tariffs.

- Finally, the ECB is on the verge of a transition of leadership to the International Monetary Fund’s Christine Lagarde, who is due to replace Mario Draghi in October; it’s one of several changes in the Governing Council.

Despite all this, the ECB will still end up adopting a looser policy stance, with the most likely announcement this week not immediate action but strong signals that (1) a differentiated rate cut and resumption of quantitative easing will follow in September, (2) this looser policy stance will be maintained for a while, and (3) all this is taken in the context of a broader review of policy parameters, including the inflation target.

The decision to do more despite the limited prospects for beneficial impact reflects the increasingly difficult dilemma that the ECB and other systemically important central banks find themselves in: unable to exit a policy paradigm that involves both ever-fewer benefits and higher risks of collateral damage and unintended consequences.

First « 1 2 » Next