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European Central Banks cut interest rates

by Jerome a Paris Thu Nov 6th, 2008 at 09:46:40 AM EST

As expected, the European Central Bank has lowered its main interest rate by 0.50%, following a similar move by the Swiss National Bank and a much more spectacular 1.5% move down by the Bank of England.

The markets, which had cheered the BoE's spectacular move, dropped again after the ECB's minimalist move, proving once again that cheap debt is the stock markets' drug of choice.

Expect the jeremiahs to once again complain about the ECB's hopeless rigidity, even though the graph above suggests that it has conducted a monetary policy which has been both loose (with real interest rates only above zero in the boomiest boom times) and flexible (closely related to - and usually slightly anticipating - eurozone inflation).

Like the Bundesbank before it, the ECB does not like to be prodded by the markets, and the FT article linked to above notes that "the ECB seems to have decided that a larger cut might have appeared a panic reaction." Today's move nevertheless suggests a strong change of mind about the dangers of inflation in the eurozone, or at least a desire to avoid any hint that monetary policy be seen as an obstacle to macro economic decisions to fight the coming recession.

Still, with a large chunk of eurozone long term retail lending (like mortagages) done on the basis of interest rates set by the long-dated bond markets, to which is added the cost of liquidity of banks, lending costs will not be going down by as much for households and businesses - and lending volumes are constrained by banks' desperate attempts at deleveraging as well as their sudden aversion for risk. Once again, this will help the commercial banks (and the large companies able to tap money markets) more than anything else.

There is a lot of talk about deflation amongst the Serious People. Crashing asset prices and deflation are not quite the same thing - but it is of course in the interest of the rich (who own an even bigger share of assets than they get of incomes) to conflate the two, once again. Thus the only truly evil inflation is made to be income increases and the only truly evil deflation that of assets.

The ECB has fought that logic more than other central banks, but the pressure seems rather strong now.

So... are you arguing (putting aside the lack of an EU government for a moment) that there should have been a fiscal response instead and no change in monetary policy?
by Metatone (metatone [a|t] gmail (dot) com) on Thu Nov 6th, 2008 at 10:06:42 AM EST
The ECB decision is not a horrible one today, and I generally support its stance so far, but it is largely powerless with today's crisis. It has done all it could and more on the liquidity front, but the problem is obviously not liquidity, but insolvency of the banks, and now it is economic recession.

The banks require wholesale recapitalisation, which is now happening belatedly, and they probably require to be taken over because right now their risk policies are as tight as they were wild before the crisis (ie they are overreacting).

The economy requires a spending boost, in the form of more money to those hardest hit or in the form of useful investment programmes in energy infrastructure, ie of the coordinated and large scale kind.

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Thu Nov 6th, 2008 at 10:30:17 AM EST
[ Parent ]
(bringing back the lack of an EU government for a moment [Metatone]):

If the ECB is largely powerless with today's crisis, while the economy requires a spending boost... of the coordinated and large scale kind, is this best to be done by individual governments? Isn't there an argument here for some degree of institutional eurozone economic governance?

by afew (afew(a in a circle)eurotrib_dot_com) on Thu Nov 6th, 2008 at 11:17:30 AM EST
[ Parent ]
Well yes, it's a clear tenet of most analyses of the eurozone that in the long term this "zone of currency" and hence "zone of interest rates" needs to be matched with a "zone of economic governance/fiscal action" to make things work out.

However, for all the reasons we all know about, it's not an easy political project. And I wouldn't want to make plans to combat the incoming potential-depression contingent on solving the political problem of European governance.

Thus, for now I think we have to work through agreements between the individual governments...

by Metatone (metatone [a|t] gmail (dot) com) on Thu Nov 6th, 2008 at 11:21:27 AM EST
[ Parent ]
But at the moment the EU Commission is taking Ireland to account for breach the Stability pact and incurring a greater than 3% budget deficit.  Is this not the exact reverse of what is actually required?

Vote McCain for war without gain
by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Thu Nov 6th, 2008 at 12:06:03 PM EST
[ Parent ]
by Metatone (metatone [a|t] gmail (dot) com) on Thu Nov 6th, 2008 at 12:55:33 PM EST
[ Parent ]
ECB has been very good throughout this crisis, IMHO. For a long time, the interbank market has essentially seized, and it was the ECB who supported the life of the system.

But there are limits to what the central bank could do, as any teacher in a monetary policy class will tell you. A temporary repeal of 3% rule is in order - it might be easy to push it though right now, and some governments are clearly itching for the fiscal stimulus that seems to be needed right now.

by Sargon on Thu Nov 6th, 2008 at 02:46:04 PM EST
[ Parent ]
to me sticking with the .5% cut seems like a very smart move, they have basically said; "yea its bad in the euro zone but its not any thing as close to fucked up as the UK".

It might focus the negativity on the UK and give them some breathing space.

by fredouil (fredouil@gmailgmailgmail.com) on Thu Nov 6th, 2008 at 03:37:07 PM EST

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