Quantitative easing everywhere?
Bank of England mulls ‘nuclear option’ of cash injection
The Bank of England is working on radical plans to inject cash directly into the economy — the nuclear option to be used only when interest rates approach zero.
In what would be a major departure for British monetary policy, the Bank is considering pressing the button on printing presses by engaging in a so-called policy of quantitative easing. It emerged after the Monetary Policy Committee cut borrowing costs by 1 percent to just 2 percent — the lowest level since 1951.
In the statement published alongside its decision, the Bank warned that “it was unlikely that a normal volume of [bank] lending would be restored without further measures.”
The measures under consideration include direct purchases of assets, such as government debt or commercial investments, by the Bank or the Treasury, as well as expanding the Bank’s balance sheet, a means of pumping extra cash into the banking sector.
The radical proposals, which are currently being explored by Bank experts, could be put into action within weeks, although they would have to be vetted by the Treasury, which is thought to remain sceptical. The main obstacle is that the policy could be found to conflict with European Union laws on how governments manage their budgets.
However, added weight was given to the proposals by European Central Bank President Jean-Claude Trichet, who seemed to hint in the press conference to announce the ECB’s 75 basis point rate cut yesterday that it may also consider “nuclear options.”
“We will look at what is necessary at any period of time,” he said. “If new decisions are needed, we will take new decisions.”
If the plans do go ahead it would be the first time since the 1970s that the Bank of England has effectively attempted to target the volume of cash in the economy, by using its balance sheet, rather than the price of money through interest rates.
The news underlines the fact that despite having slashed rates from 5 percent this year, and put around L500 billion of money behind schemes aimed at kick-starting the mortgage lending market, it has failed to arrest the financial crisis.
Danny Gabay of Fathom Consulting said: “There has been a seismic shift at the Bank of England. I think [quantitative easing] is a natural progression from where we’ve got to now. The Bank has reached a tipping-point with interest rates. With a target rate for inflation of 2 percent, this cut means that real interest rates are now at zero.
“It’s quite sensible for them to start thinking about what other things to do. The easiest thing that they could do is to under-fund the fiscal deficit.”
This would involve using the Ways and Means bank account at the Bank to buy government securities and would, in effect, amount to printing cash. In normal times such a move would be highly inflationary, but with the UK facing deflation next year such a plan is now thought to be valid.
A number of other central banks, including the Riksbank in Sweden, the Danish central bank, and the Reserve Bank of New Zealand also slashed rates as the global economic slowdown took hold.
With experts speculating that the MPC might contemplate another 1.5 percent cut, the pound dropped sharply ahead of the decision, but it later recovered to close down 1.32 cents at $1.4690 against the dollar.
Halifax reported that house prices dropped by 2.6 percent in November alone, while the Society of Motor Manufacturers and Traders announced that new car sales plummeted at the fastest rate since 1980. The total number of new car registrations last month was 100,333 — down 36.8 percent on last year’s level.
In the article by Ambrose Evans-Pritchard, he notes that the ECB is considering the same thing.
Pritchard is a good financial journalist who recognises the legal constraints which preclude more active fiscal and monetary policy on the part of the EU, but he doesn’t get the proposed monetary operations of the ECB quite right. According to him,
The Maastricht Treaty prohibits the ECB from injecting stimulus by purchasing the government debt of the eurozone’s fifteen states debt — a method known as “monetizing the deficit” or, more crudely, as “printing money.”
But it can achieve the same effect.
Not quite. According to Evans-Pritchard:
By mopping up sovereign debt, mortgage securities, or even company debt on the open market, as the Fed has already begun to do. At the moment the ECB accepts some of these assets as collateral in exchange for loans, but it has not yet hit the atomic button by buying them outright with its own freshly-minted fiat money.
In actuality, when the ECB accepts collateral for loans, it doesn’t offer non recourse funding. The owner of the securities remains liable in the case of default, so it is still well away from what the Fed is doing, say, with mortgage backed securities.
Given the lack of supranational institutions to do fiscal policy properly, and ongoing German recalcitrance to great pan-European measures in this directions, it looks like the EU will have to wait for some sort of recovery in aggregate demand in both the U.S. and Asia in order to save themselves via exports. And to think that the eurocrats who devised the euro actually had illusions of it becoming a reserve currency! The small-mindedness of German officialdom in particular is quite extraordinary.
Recognising the constraints put forward by the Maastricht Treaty in the fiscal area, Professor Jamie Galbraith made the following innovative suggestion to some key European policy makers at a recent conference in Madrid:
Common channels can also be used, notably the European Investment Bank with its new mission of health education, urban regeneration and urban environment – a broad mandate matched by an exemption of EIB borrowings from national debt limits. Let me suggest an economic principle to replace the failed neoliberal emphasis on flexibility and wage-cutting. A more egalitarian Europe will be a more efficient Europe, with more employment and less migration. This is not only a Nordic principle but also an American one: it is the exact experience of the United States under the New Deal and Great Society. The point bears on the problem of international income convergence in Europe, especially that of the accession countries. For if convergence fails, the European project has a major problem. And convergence is going in reverse right now, as capital that flowed into the East moves out. Let me suggest that a dramatic step may be required to address this issue. And if one is looking for new instruments at the European level, a suitably dramatic step might be a European Pension Union, to set a common floor under retirement income on the continental scale. This is, of course, what Social Security achieved for the United States seventy years ago.
Needless to say, this idea did not go down well with the Germans.
Anyway, here’s the rest of Evans-Pritchard article:
ECB cuts rates to 2.5% and mulls ‘printing money’
The European Central Bank has slashed interest rates by three-quarters of a point to 2.5 percent in the boldest move since the launch of monetary union and hinted at revolutionary action to head off a severe slump next year as the economic crisis ravages the car, steel, and machine tool industries.
“Tensions have increasingly spilled over from the financial sector to the real economy,” Jean-Claude Trichet, the ECB’s president, said. He added: “Global and euro-area demand are likely to be dampened for a protracted period of time.”
Sweden’s Riksbank went even further, stunning the markets with a cut of 175 basis points to 2 percent. The Swedish authorities are deeply alarmed by the collapse of vehicle sales at Volvo, as well as the large exposure of Swedish banks to the property crash in Eastern Europe
“We’re moving towards a world of zero rates in Europe and the G10 countries, perhaps as soon as the second half of next year,” said Michael Klawitter, a strategist at Dresdner Kleinwort.
Mr Trichet said the eurozone is likely to contract by 0.5 percent next year amid a “hardening” of the credit markets. This is a dramatic reversal from the ECB’s forecast of an economic rebound published in September. The bank has undoubtedly been startled by the latest PMI confidence data, which has a good record as a leading indicator and is now pointing to a brutal contraction of 2.7 percent year-on-year in early 2009.
In France, President Nicolas Sarkozy unveiled a E26 billion (L22 billion) stimulus package of tax cuts and state spending to fight unemployment. It includes E1 billion in loans for the French car industry, which is shutting a string of plants for up a month to clear an unprecedented glut of unsold vehicles. The state will build 100,000 new homes to keep construction alive.
Mr Sarkozy said the goal of restoring France’s dilapidated public finances to good order could wait for better times. “Not doing anything now would have cost us much more. We’re not going to sacrifice the present for the future. This crisis is an ordeal, a painful ordeal and a terrible ordeal, but we have to keep faith,” he said.
Italy needs a stimulus package even more badly but is having to tread with care as markets fret over some E200 billion of Italian state debt that must be rolled over next year. The yield spread on 10-year bonds has risen to 123 basis points over German Bunds. Giulio Tremonti, Italy’s finance minister, insisted yesterday that state bonds were at no risk. “Buy them. They are absolutely solid.”
Mr Trichet signalled for the first time that the bank is considering some form of “quantitative easing” (QE), the term used to describe the emergency measures pioneered by Japan during its Lost Decade and now being adopted by the U.S. Federal Reserve.
“We are supplying liquidity on an unlimited basis. We will continue to look very carefully at the situation of the market and if needed we will take new decisions,” he said, when asked about QE measures.
Julian Callow, Europe economist at Barclays Capital, said the ECB had been caught off guard as the crisis gathered pace this year but is now beginning to catch up. “They are still being too hesitant given the gravity of what is happening. Even so, it seems they are now preparing for quantititave easing and undoubtedly have other tricks up their sleeve,” he said.
The Maastricht Treaty prohibits the ECB from injecting stimulus by purchasing the government debt of the eurozone’s fifteen states debt — a method known as “monetizing the deficit” or, more crudely, as “printing money.”
But it can achieve the same effect by mopping up sovereign debt, mortgage securities, or even company debt on the open market, as the Fed has already begun to do. At the moment the ECB accepts some of these assets as collateral in exchange for loans, but it has not yet hit the atomic button by buying them outright with its own freshly-minted fiat money.
Marshall here again. At least we know that Italian bonds will still be safe. How do I know this? Because the Italian Finance Minister told us so!
Italy needs a stimulus package very badly but is having to tread with care as markets fret over some E200 billion of Italian state debt that must be rolled over next year. The yield spread on 10-year bonds has risen to 123 basis points over German Bunds. However, Giulio Tremonti, Italy’s finance minister, insisted yesterday that state bonds were at no risk. “Buy them. They are absolutely solid.”
Sure they are! Thanks to the Fed’s unlimited swap facilities extended to the ECB Italian bonds are backed by the full faith and credit of the Fed, and, by extension, we the American taxpayer! Is this a great country, or what?
Source
ECB cuts rates to 2.5% and mulls ‘printing money’ – Ambrose Evans-Pritchard, Telegraph
Bank of England mulls ‘nuclear option’ of cash injection – Telegraph
So is it a foregone conclusion now that most states will start printing money in attempt to resets the debt? If so, what’s the timeline? I think they will have to look holiday season sales data before deciding on the big move, so that puts us at end of January.