Joachim Fels (PIMCO) | By cutting the deposit rate to -50 basis points, extending forward guidance, introducing a two-tiered system for excess reserves that mitigates the adverse impact of negative rates on bank profitability, and resuming open-ended net asset purchases of EUR 20 billion per month, the European Central Bank (ECB) recently provided clarity about its prospective monetary policy stance for the foreseeable future and thus well beyond the change in leadership from Mario Draghi to Christine Lagarde that takes place at the end of October.
For details of the measures taken and the implications for the inflation outlook and financial markets, see my colleague Andrew Bosomworth’s excellent piece “European Central Bank Policy: QE Infinity” on the PIMCO Blog.
While it is almost certain that negative interest rates and net asset purchases are here to stay for a long time and that the former could be lowered further and the latter increased if needed, important questions regarding euro area monetary policy remain:
- First, is the ECB’s monetary policy strategy framework, which was last reviewed by the Governing Council in 2003, still adequategiven persistent below-target inflation outcomes and low or even ultra-low natural interest rates (on the latter see also last week’s Sunday Signposts, attached)?
- Second, and relatedly, how can fiscal and monetary policy in the euro area be coordinated to better achieve the ECB’s objectiveswithin the confines of a European Treaty that enshrines ECB independence?
- And third, following the resignation of Sabine Lautenschlaeger this past week, who will take the position in-officially earmarked for Germany in the ECB’s six-member Executive Board?
Regarding the ECB’s policy framework, it looks likely that one of the first initiatives of Christine Lagarde as incoming ECB President will be to initiate a strategy reviewlead by ECB Chief Economist Philip Lane. The last such review occurred in 2003 and resulted in a clarification of the inflation objective as being below “but close to” 2 percent and in de-emphasizing the so-called monetary pillar of the strategy, which consistent of a numeric target for the broad monetary aggregate M3. In a recent wide-ranging interview on monetary policy issues with the German daily Handelsblatt, Philip Lane said: “I think it is time for such a review.” [By the way, if you are looking for a clear and comprehensive update of the ECB leadership’s current views on monetary policy this interview is a must read – English version here.]
One focus of the coming review is likely to be on whether, and if so how, the inflation target should be modified/clarified. Is “below but close to 2 percent” still the right number? Should the target be symmetric and if so, how can this be clarified further? Should the ECB adopt a target with a memory and thus aim at correcting past under- and overshoots over time? The U.S. Federal Reserves own strategy review that is currently being conducted under leadership of our former PIMCO colleague Vice Chair Rich Clarida could provide valuable input into the ECB’s deliberations.
Another focus of the review is likely to be the range of instruments that the ECB has at its disposal. What is the level of the so-called reversal rate – the rate at which the adverse effects of negative interest rates outweigh the positive ones? Are negative rates, forward guidance, and purchases of public and high-quality private sector bonds enough? Should the ECB include yield curve control and purchases of equities and bank bonds into its potential toolkit for the next recession/crisis? Finding answers to all of these questions will require extensive work by the staff and outside experts, as well as intensive discussions within the Governing Council.
Regarding the second major question raised above – better coordination of monetary and fiscal policy in the euro area to help the ECB achieve its objectives –, this is obviously not something the ECB can address on its own. Fiscal policy in the euro area is conducted by 19 elected national governments that follow their own political agenda. Steps towards a common euro area fiscal capacity are small and slow.
For the time being, the only thing the ECB can do to enlist help from governments of countries that have fiscal room and are large enough to make an economic difference for the euro area (a convoluted way to say Germany, I know) is to convince the government and the public in those countries that the best way to eventually make an exit from unpopular negative rates and asset purchases is to support both aggregate demand and potential output growth via infrastructure investment and/or tax reductions. Mario Draghi and many of his ECB colleagues, including Philip Lane in Handelsblatt, have tried this for some time and there are some signs that public opinion in Germany on fiscal policy is becoming more supportive of fiscal expansion, but more work and convincing appears to be necessary. A new impetus could come from Christine Lagarde, who is a skilled negotiator and communicator and has close relationships with leading euro area politicians.
In this context, but also more generally, the choice of the successor to Sabine Lautenschlaeger on the ECB’s Executive Board is relevant. While there is no written rule, convention suggests that Germany, as well as France, Italy and Spain, will always be represented on the six-member Board, so the successor will almost certainly be a German, to be proposed by the German government, then recommended by the Eurogroup of Finance Ministers and finally appointed by the European Council of the Heads of States.
At this stage it is unclear who will get the post, but the following seven names have been discussed in the media over the last few days (in alphabetical order):
- Elga Bartsch, Head of Economic and Market Research at BlackRock, member of the ECB Shadow Council and previously Co-head of Economics and Chief European Economist at Morgan Stanley (where she was my colleague for many years).
- Ulrich Bindseil, Director General of Market Infrastructure and Payments at the ECB, previously Director General of Market Operations.
- Claudia Buch, Vice President of the Bundesbank, previously professor of economics at Tuebingen University and member of the German Council of Economic Experts
- Marcel Fratscher, President of the DIW Berlin research institute and professor of economics at Humboldt University Berlin, previously Head of International Policy Analysis at the ECB.
- Joerg Kukies, German Deputy Finance Minister, formerly Co-CEO of Goldman Sachs International in Frankfurt.
- Isabel Schnabel, Professor of financial economics at Bonn University and member of the German Council of Economic Experts
- Volker Wieland, Professor of Monetary Economics at Goethe University in Frankfurt, member of the Council of Economic Experts, previously senior economist at the U.S. Federal Reserve Board.
All seven are highly qualified for the position in question, which I guess is why the media are mentioning them, but I have no insights into who the government is actually considering from this or an even longer list. However, given the almost grotesque gender imbalance on the 25-member Government Council, the ECB’s main decision-making body — following Sabine Lautenschlaeger’s resignation, Christine Lagarde will be the only woman — it seems quite likely that the government will propose a female candidate.
If so, each of the three women on the above list – Elga Bartsch, Claudia Buch and Isabel Schnabel — would be an excellent choice. Not only would they bring relevant additional economic expertise to an Executive Board that is slightly short on trained economists. Also, the ECB needs another credible and authoritative voice in addition to Jens Weidmann explaining ECB monetary policy to a skeptical German public in their own language. After all, as Ben Bernanke once said, “monetary policy is 98 percent talk and only 2 percent action.”