What to make of Europe?

At its September 4 meeting, the European Central Bank lowered the main refinancing rate by 10 bps to 0.05 percent and drove the overnight deposit rate deeper into negative territory, now charging banks 0.20 per cent to park funds with the central bank.


Regarding these historically low interest rates Draghi stated the following: ‘For all practical purposes interest rates already were at the lower bound, but technical adjustments could be possible, and that’s what we did. And now we are at the lower bound, where technical adjustments are not going to be possible any longer.’

Asset-backed Securities

The Eurosystem will purchase a broad portfolio of simple and transparent asset-backed securities (ABSs) with underlying assets consisting of claims against the euro area non-financial private sector under an ABS purchase program (ABSPP). In parallel, the Eurosystem will also purchase a broad portfolio of euro-denominated covered bonds issued by Microfinance Institutions (MFIs) domiciled in the euro area under a new covered bond purchase program (CBPP3).

Interventions under these programs will start in October 2014. The detailed modalities of these programs will be announced after the Governing Council meeting of October 2. Last week the ECB announced it had hired BlackRock as consultant to advise on a program to buy ABS loans.

Fiscal Stimulus

Fiscal policies have a significant impact on economic growth, macroeconomic stability and inflation. Key aspects in this matter are the level and composition of government expenditure and revenue, budget deficits and government debt.

Fiscal discipline is a pivotal element of macroeconomic stability - ECB

The need for fiscal discipline is even stronger in a monetary union, such as the euro area, which is made of sovereign states that retain responsibility for their fiscal policies. There are no longer national monetary and exchange rate policies to respond to country-specific shocks, and fiscal policies can better cushion such shocks if they start from a sound position. During the former ECB press conference Draghi intensified pressure on European governments to play their part.

We need action on both sides of the economy: aggregate demand policies have to be accompanied by national structural policies. We should not forget that the stakes for our monetary union are high – Mario Draghi, 22 August 2014

It is time for governments to take responsibility here, since fiscal boosts can only buy time. Draghi addressed four ways in which fiscal policy could be improved: better use of flexibility within existing European Union rules; lower taxes; stronger fiscal coordination between governments; and EU action to ensure a large public investment program. 

The Danger Zone

The ECB targets an inflation rate at below-but-close to 2 percent, a level not seen since the first quarter of 2013. It has been in what ECB President Mario Draghi has previously called "the danger zone" of below 1 percent since October last year.


Core Eurozone inflation is expected to be 0.3% in August 2014, down from 0.4% in July. As the trend is deflationary, to simply speak of stickiness in core inflation is becoming an understatement. Not only does such a low figure often inhibit economic growth, the current 'deflationary' trend calls for action as the current level is far below the ECB's target of a little below 2%. Excessively low inflation makes it hard for stressed countries to regain competitiveness and also makes it more difficult for governments and the private sector to reduce debt burdens.

Spain and other troubled nations on the Eurozone's periphery are already experiencing price declines; recent data show inflation cooling in healthier northern economies, too.


With sluggish Eurozone GDP growth, and contracting Purchasing Managers' Indexes (PMI’s) of leading countries, it is time for action.

In order to kick-start their economy again, countries including France and Italy have argued for more flexibility with their budgets.

EUR/USD on our side

A strong currency makes an economy's goods and services more expensive in global markets, thereby damping exports. It also weakens inflation by reducing the costs of imported goods. The ECB does not target exchange rates, but at the start of 2014 it has highlighted the effect the strong euro has had on inflation, and has said it is an increasingly important factor on the ECB's assessment of price trends.

Indeed the small overshooting of the EUR/USD to 1.40 progressively corrected itself. In the last months, the U.S. dollar has risen in value, as its economic recovery advances faster than Europe's. Besides structural problems, a weak euro bought Europe some extra time.

A Japanification of the Euro area?

The risk of a Japanification of the euro area seems high and rising, since deflation was not on Japan’s radar either early 1990’s.

It is just that the zero interest rate is keeping the budget pressure concealed. If interest rates rise, paying the interest on the national debt will become a problem. If, on the other hand, the current trend of deflation continues, a larger and larger amount of debt will accumulate, still without any alarms going off.

And “when you realize it,” when interest rates finally do rise, “it will be too late.” - Takatoshi Ito, Ph.D. ’79, a professor of economics at the University of Tokyo

In order to avoid a Japanese-style lost decade, Eurozone’s wages are of major importance.


There seems to be some room on the ECB’s balance sheet.