QE, versão BCE

Leitura recomendada: Charles Wyplosz, sobre as decisões recentes do BCE e sobre um tema que circula ali por baixo. Is the ECB doing QE?, no Vox. Sobre o mesmo assunto, ler também ECB: QE or QT?, de Antonio Fatas

The ECB has announced its intention to boost liquidity. With traditional QE, as practiced by the US Federal Reserve, the Bank of England, and the Bank of Japan, the central bank buys securities – mostly public debt instruments – in pre-announced amounts according to a published schedule. As a result, the amount of liquidity creation is known ex ante and certain to happen.

In the case of the ECB, this will require market participants to securitise existing or new loans. The existing amounts of Eurozone asset-backed securities is presently believed to be of the order of €1 trillion, to be compared with the $2.4 trillion created by the Fed through its various QEs. Not all of it will be accepted by the ECB for quality reasons.

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This demand-driven process means that no one knows how much liquidity the ECB will be able to create. Its signalling power, therefore, is limited relative to traditional QE. One can already anticipate financial markets debating the size and timing of the programme. In the US, doubts only surfaced when the Fed started in 2013 to send warnings that QE was not forever.

The hope is that the existence of the ECB programme will encourage lenders to lend more under the assumption that these loans will then be sold to the central bank. Two assumptions come into play here.

• First, that current bank lending, which has been negative in net for several years, is restrained by a lack of liquidity.
• Second, that securitisation of these new loans will develop.

The first assumption is contradicted by the fact that banks hold some €100 billion in excess reserves, for which they receive a negative interest rate. Lack of liquidity cannot explain negative credit growth. The alternative explanation is that there is not enough demand, which is plausible in the midst of a recession. If so, the programme will not have any impact. Yet another explanation is that banks do not lend because they are too risk averse. The ECB programme will succeed if the securitisation process allows them to pass the risk on to the ECB.

The ECB programme will encourage securitisation. By selling their loans to securitisation agents, banks will get rid of the associated risks. Thus, the best hope is that risk-averse banks will start peddling large amounts of loans, and convince their customers to take them, because they will not bear potential losses. The ECB considers that European asset-backed securities will not be as risky as their toxic US counterparts of 2008 because they will not rely on the infamous subprime loans. Indeed, subprime loans cannot really exist in Europe because consumer protection laws effectively ban them. All this is true, but one still has to explain why banks are so afraid to lend.

• One reason is that banks are busy repairing their balance sheets through deleveraging because of new regulation and stricter stress tests.
• Another reason is that the on-going recession cuts into corporate rates of return, and that high unemployment rates mean that lending to households is inherently risky.

The first reason may evaporate later this year as the result of the Asset Quality Review and tough stress tests that will force weak banks to recapitalise. It may also mean that banks will have one more argument to delay, or possibly even roll back, the new regulation designed to make them less fragile and costlier to bail out. That would be a disaster.

The second reason describes a vicious circle. The ECB must hope to break it. Yet, it is hard to see how the process starts other than through more risk-taking by banks, passed on to the ECB. The bet, then, is that loans that now appear risky will turn out to have been safe because the process will have triggered a recovery. In that view, in the end of it all, the ECB will not suffer significant losses. Maybe, but the ECB will have to take the risky bet.

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The ECB programme is more complex, less certain to work and riskier than traditional QE. There must be good reasons for the ECB to have chosen such a convoluted route. To start with, the European banking system remains fragmented. That means that the normal channels through which liquidity trickles down throughout the Eurozone are not operating well (Al-Eyd and Berkmen 2013). The ECB programme is designed to lend to lenders, indirectly through securities, thus bypassing the broken channels.

In addition, traditional QE involves buying large amounts of public debt. In the Eurozone, this is highly contentious. Ideologues will be prompt to describe QE as the backdoor for debt monetisation. To be effective, the ECB would have to choose public debts of countries in bad shape, since national bonds are now concentrated on the balance sheets of the respective national banks. That will reinforce the debt monetisation syndrome. Furthermore, if one believes that many countries face unsustainable public debt levels, this means that some restructuring is unavoidable.⁴ It could well be that public bonds are riskier than the loans that will be created under the new ECB programme.

No one should believe that the ECB’s task is an easy one. With inflation way below its definition of price stability, the ECB must ‘do something’. Indeed, had ‘something’ effective been done a year ago, the situation today would be less pathetic. Its version of QE, however, is both uncertain and risky. It all comes down to a bet that easier lending conditions will restart the Eurozone economy. Is the bet likely to pay off?

One can only wish so, even though it rests on many dubious assumptions, as described above. The main source of optimism may lie elsewhere. If liquidity does increase by a few hundred billion euros, the euro will depreciate. A sizeable and early depreciation is really the best that can happen. Rising exports will trigger the recovery, which will encourage borrowing. Lending will follow as risk aversion declines, leading to more liquidity creation and yet more depreciation.

Maybe this “hundred billion” debt is the best that the ECB can do given the Eurozone’s complex political situation. But it remains a bet, with a highly risky downside. Traditional QE, on the other hand, may not produce wonder, but certainty of liquidity creation seems to work and it can provoke the desired depreciation that is the key to success.

Um novo modelo de disciplina fiscal

Como garantir a discplina fiscal na Europa? Charles Wyplosz avança hoje, no Vox, uma proposta inspirada no modelo dos Estados Unidos. Fiscal Discpline in the Euro Zone assenta no modelo do Fiscal Compact e adiciona-lhe apenas a certeza absoluta de que a no bail out clause é mesmo para levar à letra. Uma forma de o fazer, defende Wyplosz, era permitir o default da Grécia.

The debt legacy shuts off key exits from the circle of impossibilities. After all, governments with much lower debts would have the fiscal space needed to end austerity and pursue expansionary policies. How then can debts be lowered fast enough to save the euro?

One solution would be a burst of inflation. That cure, however, is worse than the disease. The only remaining solution is debt restructuring. And it would be a solution since a vast body of literature (summarised in Reinhart and Rogoff, 2009) shows that defaulting countries quickly recover market access. Sovereign restructuring sounds radical, but much less so if it is seen as (i) an act of desperation arising from an unprecedented situation, and (ii) something that will never happen again.

The ‘never again’ requirement is the connection between legacy and the fiscal discipline exigencies (…)

What is missing is the no bailout rule. While it is already in the European Treaties, its credibly was shattered by the Greek, Irish and Portuguese packages. The task facing EZ leaders is to rebuild the credibility of the no bailout clause. This will be difficult. Traumatic events and extremely public discussion will be necessary. Debt restructuring by several Eurozone nations would provide one such vehicle. Such defaults would be so fraught with domestic and international political turmoil that future Eurozone policymakers would do whatever is necessary to avoid finding themselves in the same situation in the future. The never-again pledge, in other words, would quickly gain credibility.

Any doubts? Just imagine what would have happened had the no bailout rule been invoked in May 2010. Greece would have gone to the IMF and defaulted on its smallish public debt of 120% of GDP. By now, the crisis would be over.

Em defesa da união bancária

Charlez Wyplosz explica hoje, no Vox, o que está em causa com uma união bancária. Banking union as a crisis managment tool.

It is essential to understand that a partial banking union is no better than no banking union at all, and possibly worse. Imagine that we only have a single regulator and that the common supervisor only looks at large banks. Imagine that a series of governments, small and large, restructure their public debts, an occurrence that many regard as unavoidable. Because banks typically hold large amounts of national bonds, a public-debt restructuring is likely to cause deep losses in small and large banks. The 2007-8 scenario has amply shown how mutual suspicion promptly steps in and brings the interbank market to a halt. The ECB must then provide liquidity to individual banks, small and large. In addition, some banks may fail, bringing along others. The ECB is facing its role as lending in last resort. If it only supervises large banks, it cannot provide liquidity and, if need be, emergency assistance to the smaller banks. Financially hard-pressed governments will need to provide resources that they do not possess and cannot even borrow. Healthier governments may start down the road followed by Ireland and Spain and find themselves losing market access as well. Large banks too will be engulfed. With no resolution authority, the ECB will not feel able to inject amounts that could reach several trillions of euros. Apocalypse now.