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Home > Blogs > Anthony Harrington > When the ECB looks at itself, what does it see?

When the ECB looks at itself, what does it see?

ECB Policy | When the ECB looks at itself, what does it see? Anthony Harrington

There is no shortage of commentators out there willing to give the European Central Bank a good kicking. The comments have been trotted out many times – asleep at the wheel while the world raced to the cliff edge; way behind the Fed in lowering interest rates; fixated on price stability when deflation is the real enemy; still out of touch with what needs to be done to regulate Europe’s banks; and so on and so forth. Unsurprisingly, perhaps, this is not the picture that ECB insiders see. They hear the noises but to them, what is being described is fictional rather than real.

In a recent speech, Gertrude Tumpel-Gugerell, a member of the Executive Board of the ECB, reviewed the Bank’s policy responses to the global financial crisis and made it clear that in her view, the Bank had done pretty well, despite the fact that her opening remarks included the observation that: “The important thing is not to stop questioning.”

Reviewing the ECB’s responses to the crisis, Tumpel-Gugerell pointed to three actions taken by the ECB. First, before the crisis broke with the failure of Lehman Brothers, the ECB acted “to address severe tensions in the interbank market”. Banks were already starting to fear counterparty risk and interbank lending was drying up.  Second, after the failure of Lehmans on September 15 2008, the ECB “reduced key interest rates to unprecedented low levels”. (Tumpel-Gugerell does not mention the fact that the ECB’s action lagged the Fed’s by a considerable period, nor did it slash rates as deeply as the Fed, since it was still fixated on controlling inflation, not on preventing a depression). Tumpel-Gugerell points out that the ECB also “introduced a series of non-standard measures to support credit provision by banks to the euro economy”. There were five parts to this. Banks were given longer loan times by the ECB, which also loosened its criteria on collateral, enabling the banks to turn somewhat dodgy assets into cash. It opened dollar drawing rights with the Fed, which gave banks access to foreign currency and initiated a covered bond purchase programme. Finally, banks could borrow as much as they needed at a (low) fixed rate. This was all good stuff and undoubtedly helped to put a floor under the crash. The third major thing the ECB did, in May 2010, when EU sovereign debt became an issue, was to intervene in the debt securities market.

Tumpel-Gugerell points out that after the ECB’s first step money market rates came down from their 2008 peak. In technical terms:

Spreads between secured and unsecured money market rates declined significantly: for example, the spread between the three-month EURIBOR and the three-month overnight index swap rate decreased by 170 basis points from its peak recorded in October 2008, falling to about 30 basis points one year later and remaining close to this level thereafter.

There is also no doubt that the bank’s enhanced credit support measures improved the funding situation of euro area banks, and secondary market activity began to revive by 2009. Tumpel-Gugerell also argues that the ECB’s low interest rates to euro area banks enabled those banks to pass through rate decreases to the general economy. Average short-term rates on mortgages and on loans to non-financial businesses came down about 3.1 to 3.4 percentage points. Lastly, of course, the steps taken by the ECB on the sovereign debt crisis have undoubtedly quietened market fears, at least for now.

All of this is good news, Tumpel-Gugerell points out, and the ECB feels justified in giving itself a mild round of applause for a job well done.

“Overall, I believe that the bold and decisive measures that we have taken since autumn 2007 have been instrumental in preventing dramatic disruptions in the functioning of specific financial market segments. We have avoided severe impairments in the provision of credit to firms and households, and have prepared the ground for a gradual recovery of the euro area economy from the worst cyclical downturn experienced since the Great Depression. Indeed, after a period of sharp decline, the outlook for growth is improving. Business and consumer confidence indicators have trended upwards over the last few quarters and the Eurosystem staff macroeconomic projections, as well as those of other organisations, foresee a further rebound in GDP growth in 2010 and 2011.

The Bank has already managed to withdraw half of the €440 billion it fed into the market as part of its liquidity operation and it has done so without creating any renewed tensions in the interbank money market.

The problems ahead, Tumpell-Gugerell says, are threefold. First there is the (intractable) difference in productivity between member states (she carefully does not draw any Northern Europe/Southern Europe comparisons). Second there is the problem of public finances, with no real compulsion mechanism in place to force governments to behave prudently. Third, there is of course the thorny, and as yet unsolved, issue of how to regulate the financial markets. TG wants to see “close oversight of relative competitiveness” and “a surveillance mechanism” introduced, but there is nothing in her speech which indicates how this might be achieved. Much hangs, she suggests, on the introduction of the European Systemic Risk Board, to conduct macro-prudential oversight at the European level. For some commentators, this will be seen as a classic ECB reaction. Do some technical things rather well, point to some massive challenges and then pretend that an as yet untested committee will solve them at some not too distant date. Definitely one to watch.

Further reading on ECB policy and bank regulation:

Tags: central banks , EU , European Central Bank , financial crisis , fiscal stimulus , regulation , sovereign debt , transparency
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