January 20, 2015 5:34 pm
Bolder steps from Europe’s central bankers
The ECB’s QE programme must now happen — the eurozone economy is at stake
The surprise decision created turmoil. By January 20, the Swiss franc had appreciated by 18 per cent against the euro, the currency of its principal trading partner. With core inflation near zero, deflation in Switzerland seems inevitable. So does a recession.
Why end a policy that had delivered such enviable stability? The obvious answer is that the SNB feared huge inflation if it remained pegged to the euro, particularly after QE began — and bigger losses on foreign currency assets the later the peg was dropped. Neither fear is compelling, as Willem Buiter, Citigroup chief economist, argues. It is possible to hold down the value of a currency one creates oneself forever. It is true that the SNB’s balance sheet is already large, at about 85 per cent of gross domestic product. But it had stabilised, and as Mr Buiter notes: “There is no technical limit on the size of the central bank’s balance sheet, in absolute terms or relative to GDP.”
Furthermore, the Swiss could have curbed inflationary dangers without abandoning the peg, for instance by increasing reserve requirements on banks. A sovereign wealth fund could have been set up to manage huge holdings of foreign assets.
Even if a peg to the euro was no longer thought to be desirable, it could have been given up without going cold turkey. The government could instead have pegged the franc to a basket of currencies, which would have anchored its purchasing power while allowing it to move more freely against the euro.
Alternatively, it could have allowed the franc to move within a predetermined range, denying speculators a one-way bet on the value of the currency.
More interesting would have been a decision to go further in the direction of negative interest rates than the minus 0.75 per cent now imposed.
To make such a move stick, the authorities would have had to place limits on withdrawals from bank accounts or move entirely to electronic money, to prevent people from protecting their purchasing power by moving into cash. Needless to say, such radical ideas would horrify the prudent burghers of Switzerland.
QE is going to horrify the burghers of Germany, too. But it must now happen since it is the only way still available for the ECB to meet its definition of price stability. Its credibility is at stake. So, too, is the eurozone’s economy.
Everything is fine in Germany. But Germany is not the eurozone. Everything is less fine elsewhere.
The eurozone is in a slump, afflicted by the “chronic demand deficiency syndrome” that is the world economy’s biggest current weakness. Core inflation is 0.7 per cent, far below the ECB target of “below but close to” to 2 per cent. Five-year inflation expectations have fallen to 1.6 per cent. Nominal demand was a mere 2 per cent higher in the second quarter of 2014 than in the first quarter of 2008, while real demand was 5 per cent lower (see chart).
The difficulty is not that, to avoid the bogey of debt mutualisation, purchased bonds will end up on the balance sheets of national central banks. That fudge might even be an advantage to the more indebted countries. If the profits were divided in proportion to equity in the ECB, Germany would benefit from the higher interest rates paid on, say, Italian debt. By insisting instead on strict national responsibility, Germany will hurt itself.
The difficulty is rather that German opposition may fatally undermine the credibility of Mr Draghi’s insistence that the ECB will keep inflation on target. Similarly, the resolute opposition of the German establishment to fiscal deficits even when the yield on its own 30-year bonds is 1.1 per cent — virtually free money — hampers the use of fiscal policy throughout the eurozone. The emphasis on the wickedness of debt, regardless of what it costs, is pathological. No other adjective will do.
It is all up to the ECB. It may well fail, not because it is too independent but because it is not independent enough. Similarly, the eurozone may fail, not because of irresponsible profligacy but rather because of pathological frugality. In the end, the ECB must try to do its job. If Germany cannot stand that, it may need to consider its own Swiss exit.