When there is no other option on the table but an extreme measure, you know you might be in the final stage before the collapse. The EU has been staring into the abyss for quite a long time already and every effective tool that has been used was only good enough to kick the proverbial can down the road — only to worry about it again when the same problem resurfaces, then rinse and repeat with a different technique. Whether it will collapse soon can only be told by time alone.
The European Central Bank wants to spur lending by banks in Southern Europe, but conventional methods have shown little success so far. On Thursday, ECB officials will consider monetary weapons that were previously considered taboo.
From Mario Drahgi’s perspective, the euro zone has already been split for some time. When the head of the powerful European Central Bank looks at the credit markets within the currency union, he sees two worlds. In one of those worlds, the one in which Germany primarily resides, companies and consumers are able to get credit more cheaply and easily than ever before. In the other, mainly Southern European world, it is extremely difficult for small and medium-sized businesses to get affordable loans. Fears are too high among banks that the debtors will default.
For Draghi and many of his colleagues on the ECB Governing Council, this dichotomy is a nightmare. They want to do everything in their power to make sure that companies in the debt-plagued countries also have access to affordable loans — and thus can bring new growth to the ailing economies.
The ECB has already gone to great lengths to achieve this objective. It has provided the banks with virtually unlimited high credit and drastically lowered the collateral required from the institutions. The central bank has also brought down interest rates to historical lows. Since early November, financial institutions have been able to borrow from the ECB at a rate of 0.25 percent interest. By comparison, the rate was more than 4 percent in 2008.
So what measures are still on the table and how would they effect the European economy?
One scenario that drives fear into the hearts of all savers is the so-called negative interest rate. It would mean that the banks would have to pay a fee for the money they park, currently without interest, at the ECB — a kind of penalty interest rate. The idea is to create an incentive for the institutions to loan out extra money to other banks, in Southern Europe for instance. This, it is hoped, would then lead to more lending to businesses and consumers.
The penalty interest rate was already a topic at the last Governing Council meeting in early November. ECB board member Benoit Coeure recently confirmed that the negative interest rate had been discussed and considered from both a technical and legal perspective. “The ECB is ready,” he said.
Experiences with negative interest rates have so far been rather poor. Denmark tried it in 2012 with an interest rate of -0.1 percent on deposits at the country’s central bank. The result: Many banks simply passed on the higher cost to the consumer.
The ultimate means the ECB has for keeping market interest rates low is to purchase large quantities of bonds from investors. Other central banks including the Fed in the United States, the Bank of England and the Japanese central bank are already using this instrument more or less successfully. The idea behind “quantitative easing” is that a central bank purchases government or company bonds on the market and, by doing so, drives down prices — e.g. interest rates.
Besides, experts believe the purchase of corporate bonds or packaged corporate loans would only have a limited effect on interest rates. The market may be large enough in the United States for such an undertaking, but it is simply too small in the euro zone.
Full article: Weapons of Last Resort: ECB Considers Extreme Crisis Measures (Spiegel Online)