ECB Monetary Policy Is Missing a Trick

In the global currency and liquidity war, the European Central Bank (ECB) has been at a disadvantage.

The strict legislation that governs the ECB monetary policy and the narrow mandate the central bank has been allocated have meant that the ECB has had to resort to increasingly creative ways to keep up with its less-inhibited peers like the Fed, the Bank of England or the Bank of Japan.

The result has been a strong euro that has hurt eurozone exports and delayed the recovery, and painful adjustment via deflation and unemployment in its periphery countries.

Lately, the situation has improved a bit. The new German coalition could breathe new life into the southern eurozone countries’ economies, as an article by Valeria Palumbo and Marco Troiano at shows.

Over at, Lars Christensen argues that, because the ECB’s operations are sterilized – therefore they have no impact on the money base – they cannot even be called monetary policy.

“Monetary policy is two things. It is the central bank’s ability to increase or decrease the money base. It can do this by buying or selling assets in the market place. And second, it is the central bank’s ability to communicate about future changes in the money base (forward guidance),” he says in this article.

The ECB’s maverick president, Mario Draghi, is probably aware of that. If anything, it is worth watching the central bank’s monthly news conference just to see what variation of “whatever it takes” he will come up with next.

Draghi’s talent for making apparently innocent statements which a short while later prove to be as effective in moving markets as real monetary policy is almost legendary. The issue is, will he be able to keep it up?

ECB MONETARY POLICY: INDEFINITE                           

Take the LTROs. When first introduced, the Long-Term Refinancing Operations did not immediately cause a stir in the markets. Only when their significance actually sank in – cheap money, any amount, for three years – did markets rally.

The same goes for the central bank’s Outright Monetary Transactions (OMT). At the beginning, sceptics were quick to point out that there was so much conditionality attached to them that they would never be used. As it turned out, so far they didn’t need to be.

But it looks like the ECB may have been painting itself into a corner and is now under pressure to keep coming up with ways to distract the markets’ attention from the fact that, as always, its hands are tied.

Analysts agree that it will deliver no bombshell at this week’s meeting, the last for 2013.

But if it really wanted to boost the recovery, here is what it could do: instead of a new LTRO (advocated by strategists such as RBS’s Alberto Gallo), why not announce an ITRO?

An “ITRO” would be an Indefinite-Term Refinancing Operation. Cheap money indefinitely, for as long as banks need it, under the understanding that they will return it to the central bank when they’re done with it.

With interest rates at virtually zero, this could become the new ECB monetary policy.

Technically, the ECB could do this quite easily. Its status prevents it from monetising government debt directly – buying bonds from eurozone governments – but it does not forbid it from printing money by just lending it to the banks and letting them do the quantitative easing instead.

There would be many advantages to such a measure. Firstly, banks in the eurozone would be given a new lease of life and, free from worries about liquidity, they could lend money to the myriad of eurozone companies who need it.

Secondly, it would be a very strong signal to the markets that, although no backstop is in place before the asset quality review that the ECB will begin shortly under its new responsibility as single supervisor, no systemically-important bank in the eurozone will be allowed to collapse.

Thirdly, it would show the other big central banks that the ECB can conduct quantitative easing of its own, allowing the eurozone to join the currency war rather than just be a victim of it.

And finally, it would allow Draghi a break from having to think of clever ways to conduct monetary policy by speech rather than action. After all, even the best performers need to get some rest.