The efficiency of a monetary policy is disputable in recent times, especially in the Euro Area. But it is not a monetary policy to blame because it works in sovereign countries with their own fiscal policy. It is the design of the Eurozone itself that makes the European Central Bank’s actions ineffective, whatever they are.
The unending crisis in the European banking system is clear proof. In a sovereign country, adjusted monetary policy in combination with so called fiscal policy is enough to manage a banking sector during liquidity problems. It means that if banks stop trusting each other and do not lend money to each other any more, a national central bank wades in and provides temporarily some cheap money to stave off a threat and give the government (fiscal authorities) time to solve the underlying solvency problems. The Euro Area does not have this incredibly important mechanism.
The banking rulers in sovereign countries are closely connected to the ruling elite and the National Central Bank (NCB) authorities. Liquidity problems that emerge from solvency problems (too many failing loans) are solved not only by NCB but also by politicians with fiscal measures. Governments can rescue a bank by forcing tax-payers to finance a bail-out or nationalize a bank or they can impose new rules adjusted to local circumstances. National governments have a plethora of measures to support their banking system like mandatory conversion of foreign currency mortgages into local currency mortgages, temporary moratorium on foreclosures and repossessions if people fall behind on their payments, outsourcing national electronic payment system to commercial banks etc. Commercial banks are integral part of the money creation policy. In many countries commercial banks that provide an electronic payment infrastructure are state-owned. In Japan the state still owns the Japan Post Bank, while in Europe these state-owned post banks have been privatized during the last decades.
The Euro Area does not have its own fiscal authorities, so such solutions cannot be implemented at large. Banking system problems are only being solved by monetary authorities. They have no power to change systemic drawbacks, so the ECB’s liquidity provision is peaking a third time in recent eight years and certainly it is not the end.
The Euro Area consists of 19 different economies. Some are smaller, some are bigger. Some are more productive, some are less. Some banking sectors are huge, some are minor. Setting the interest rates within the Euro Area is not easy because ECB’s interest rates could be too high for Italy and too low for the Netherlands or Germany. (Countries like the Netherlands can afford to bail-out their banks while Greece and Portugal need another approach. In Italy there is no political support for a bail-in while in Cyprus this could be done overnight. The European unified monetary and banking policy has forbidden this regional approach.) That is why fiscal and monetary policies had better be inseparable. Disparities are mutually compensated.
This possibility does not occur in the Euro Area. Effects are visible on the graphs. The ECB had to provide liquidity in a traditional way (among others through longer-term refinancing operations) in the years 2009-2010 and 2011-2013 during the financial crisis and the euro crisis. But it did not work out, as S&P stated in 20131)LTRO failed to heal fragmented euro zone – S&P, Source: Marketwatch 2013-03-26! So the ECB had to launch the new and unconventional liquidity program: the so-called quantitative easing.
However, the signs that the QE will not succeed were seen already in the years 2009 and 2011, where two first bond purchase programs were initiated and the problem was not solved anyway, as it “failed to aid smaller but more cash-strapped banking systems”2)ECB Market Intervention: Covered Bond Purchasing Programme (CBPP), Source: Place du Luxembourg 2012-02-22.
Nonetheless, the ECB authorities decided to release the unprecedented massive asset purchase program. It can already be seen what the effects are. The inflation is low, the growth is weak and the banking sector crisis is escalating again, as we wrote recently. The ECB is yet considering prolonging the QE program beyond March 2017 and it will have to be continued as cheap money has become a drug for the financial system and the main solution for the unreliable banks in Southern Europe to remain on the surface.
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