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We've been there before, as I discussed in my FT piece (ft.com/content/bf1057…).
We've lost count of the number of times the ECB had to deal with the consequences of other policymakers' mistakes, incompetence or inertia, having done the right thing before. Sad! (2/n)
We've lost count of the number of times the ECB had to deal with the consequences of other policymakers' mistakes, incompetence or inertia, having done the right thing before. Sad! (2/n)
A commonly held view is that the ECB has limited room to ease, or indeed should *not* ease because fiscal policy is the only solution. Sure, but then what? There's little hope of an imminent fiscal response, and the ECB has a mandate they cannot ignore. (3/n)
Rather, the uncomfortable question is what the ECB should do, if/when risk contingencies materialise. The answer is both very simple and very complicated. (4/n)
Simple because the ECB made it clear that all instruments were available, with no limits within the mandate. Complicated because "the cost of using any given instrument might be increasing" (Coeuré) while the political environment might complicate things further. (5/n)
That said, Coeuré made two very powerful remarks: 1) any instruments would be calibrated appropriately; 2) "the QE limits are ours". (6/n)
The discussion will now start on risk contingencies, and whether they should be changed from Draghi's Amsterdam speech:
- unwarranted tightening of financial conditions => rate cut
- impaired transmission => bank credit easing
- de-anchoring of inflation expectations => QE
(7/n)
- unwarranted tightening of financial conditions => rate cut
- impaired transmission => bank credit easing
- de-anchoring of inflation expectations => QE
(7/n)
Waiting for the Fed, the path of least resistance could see the ECB cutting rates as a first step while discussing tiering, if the contingency is indeed broadened beyond EUR appreciation. Biggest risk is that a delay forces a bolder policy response later on. (8/n)
On QE, the choice looks binary between raising the issuer limits (say, to 50%) or abandoning the capital keys. The former cannot be ruled out after Draghi & Coeuré's comments. The latter still looks very difficult politically. (9/n)
In practice, the ECB could exploit QE flexibility, raising the share of corporate bonds, the limits for supranationals, the deviations from capital keys, etc. And they could try a new approach with no ex ante targets for monthly purchases, because this time is different. (10/n)
But, credibility of any announcement would be key. If the ECB decided to raise issuer limits from 33% to 50%, a rough estimate suggests they do QE2 at a €50-60bn pace for about 2 years, using maximum flexibility. A game-changer. (11/n)
Perhaps the boldest move of all would not be for the ECB to buy equities, but bank debt - the controversial albeit ultimate credit easing bazooka. Let's just hope it won't be necessary... (end)
