August 22 - 28, 2012
FinancialMirror.com
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Standards for Non-Standard Monetary Policy The widespread introduction of unconventional monetarypolicy measures by major central banks has been a defining characteristic of the global financial crisis. We have seen enhanced credit support, credit easing, quantitative easing, interventions in currency and securities markets, and the provision of liquidity in foreign currency – to name but a few of the measures taken. Some view these measures as a continuation of standard policy by other means. Once nominal interest rates cannot be lowered further, central banks use other tools to determine the monetary-policy stance. They have reached the end of the road, so they shift into four-wheel drive: they expand their balance sheets and inject liquidity to influence the structure of yields and returns and thereby stimulate aggregate demand. But when central banks return to the road – that is, exit from the non-standard measures – they must retrace their path, first unwinding unconventional policy, and only then raising interest rates. Let me suggest a different view. Say that key interest rates are to be set at levels considered appropriate to maintain price stability, drawing on regular, comprehensive assessment of economic and monetary conditions. Following standard practice, interest rates can be more or less significantly positive, very close to zero, or at zero. But, whatever the level of nominal interest rates, the monetary-policy stance established in this way has often been poorly transmitted to the economy, particularly in times of acute crisis. During the financial crisis, market functioning was impaired, at times very profoundly. Non-standard measures helped to clear standard measures’ transmission path. By this logic, if the transmission of standard measures is impeded in a significant way, non-standard measures can offer support. And, as for the exit, standard and non-standard measures can be determined largely independently. Policymakers are not obliged to unwind non-standard measures before considering interest-rate increases, or to push interest rates to the zero lower bound before considering unconventional measures. Standard measures depend on the medium- and longterm outlook for price stability, whereas non-standard measures depend on the degree of dysfunction of the monetary-policy transmission mechanism. This second view has characterized the European Central
Bank’s approach to monetary policy since the start of the financial crisis. The ECB’s first non-standard measure – unlimited supply of liquidity at fixed rates against appropriate collateral – was introduced in August 2007, when the minimum bid rate of its main refinancing operation was 4.25% – nowhere near the zero bound. Non-standard measures were required to ensure that the monetary-policy stance would be more effectively transmitted to the broader economy, notwithstanding the dislocations observed in some financial markets. Obvious, unconventional measures, if not carefully moni-
By JEAN-CLAUDE TRICHET
tored, might have the unintended consequence of creating an abnormally benign financial environment for markets, commercial banks, and sovereigns. This, in turn, could delay needed improvements in financial regulation, balance-sheet repair by banks, structural economic reform, and fiscal adjustment. As a result, non-standard measures must satisfy five conditions. First, they must be as commensurate as possible with the degree of market dislocation and disruption of market that they aim to counter, which is always a matter of judgment. In most cases, the measures must be tailored to avoid the total disruption of markets. The ECB has never hesitated to increase or decrease the scope of its non-standard tools – in particular, the duration of the non-standard supply of liquidity – depending on the abnormality in the functioning of the financial system. Second, the measures must be accompanied by forceful messages to commercial banks to address their medium-term recapitalization and balance-sheet-repair issues. To the extent that banks are, by far, the ECB’s main instrument for “nonstandard” refinancing, this message is particularly important in Europe. Third, the measures must be accompanied by equally forceful messages, when and where needed, to the governments
concerned. When non-standard measures are required because of loss of confidence in sovereign debt, such messages must seek to avoid the measures’ failure by highlighting the risk of major additional difficulties in the future. Fourth, in the case of Europe, the European Union institutions, as well as the member states, must be urged to strengthen economic governance, including through close monitoring of individual countries’ economic and budgetary policies. The ECB’s governing council has been highly vocal on this issue since the start of the crisis. Finally, to the extent that the combined non-standard measures of the advanced economies’ central banks are creating a very substantial structural change in the global economy’s monetary and financial environment, it seems necessary to call for the appropriate reinforcement of global governance. As long as these central banks consider non-standard measures necessary, they are entitled to be vocal advocates of the necessary reforms of global finance; the necessary adjustment of global imbalances within the framework of the G-20; and the decisive contribution of multilateral lenders. The ECB’s decision in December 2011 to launch its longterm refinancing operation, which supplies low-cost three-year financing to commercial banks, meets these five conditions. The LTRO’s duration, in particular, is appropriate, given the growing threat of major dysfunction in the European banking sector in October, November, and at the beginning of December last year. Moreover, ECB President Mario Draghi, my successor, made loud and clear the importance of reinforcing banks’ balance sheets, adjusting individual countries’ strategies, and improving governance in the eurozone and the EU as a whole. In all of these domains, as well as at the global level, where reform is equally urgent, there is no longer any room for complacency. Jean-Claude Trichet, a member of the Board of Directors of the Bank for International Settlements, was President of the European Central Bank (2003-2011) and President of the Bank of France (1993-2003). © Project Syndicate, 2012. www.project-syndicate.org
Eurozone shuttle diplomacy to pick up pace before critical month After a brief summer lull, euro zone leaders are gearing up for a round of shuttle diplomacy in the run-up to what could be a crucial month in the 2-1/2-year debt crisis. Greek Prime Minister Antonis Samaras will fly this week to meet German Chancellor Angela Merkel and French President Francois Hollande. Earlier in the week, he will see Jean-Claude Juncker, who heads the group of euro zone finance ministers. Merkel and Hollande will meet on Thursday, a day before the Greek premier arrives in Berlin, German government sources said, and the round of talks will extend well beyond Greece. Merkel, who was in Canada over the weekend, will visit Spain’s Mariano Rajoy early in September, and Italy’s technocrat leader Mario Monti has said he would travel to Berlin before August is out. The flurry of activity presages a crucial period for the euro zone after European Central Bank President Mario Draghi bought a measure of calm by announcing he would do whatever it took to shore up the bloc, including tackling high Spanish and Italian borrowing costs. On September 6, the ECB may spell out at its monthly policy meeting exactly how it could intervene in the bond market if asked. Markets will be on red alert for ongoing signs of internal
opposition after Bundesbank chief Jens Weidmann made clear his reservations about the plan. Six days later, Germany’s constitutional court will deliver a ruling on the euro zone’s permanent ESM rescue fund before which Berlin cannot ratify it. Dutch elections are held on the same day. The expectation is that the court will not block the fund’s inception but it could demand greater political oversight. Draghi has said the ECB could only intervene to lower borrowing costs if a euro zone sovereign had first asked for similar help from the bloc’s bailout funds, to which conditions would be attached. On September 14/15, European Union finance ministers meet in Nicosia. By then, the troika of EU, IMF and ECB inspectors may have delivered a verdict on Greece’s debt-cutting progress. Rajoy and Monti, who have consistently urged the ECB to act, are expected to put their heads together later in September. Financial markets are stuck in a rut, knowing that next month could see fireworks. “Everything depends on the data and ECB policy signals, what exactly they will do and when they will do it. Will Spain request aid?” said Nordea rate strategist Niels From.
GREEK PROGRESS Spain remains the biggest concern for euro zone leaders since a full bailout would stretch its resources to the limit. Having insisted that Madrid needed no sovereign aid, Rajoy has now said he would consider seeking further help on top of a bank bailout of up to 100 bln euros but says he needs to see the ECB’s cards first. In three weeks time, he might. “Until we know what decision the ECB has taken on this matter, we aren’t going to take one either,” Rajoy said. Samaras will meet Merkel on August 24 and will insist he can ram through an austerity package worth about 11.5 bln euros — a key condition to continue receiving EU/IMF bailout funds and avoid default and a possible exit from the currency club. “Our key priority is to regain our credibility by showing our determination,” a Greek government official said. Samaras will also raise a long-standing proposal that the austerity measures be spread over four instead of two years, to soften their impact on the Greek economy. No formal request will be made but the proposal will be broached as part of exploratory talks, the official said. Berlin insists that Athens honour its pledges but will listen to what Samaras has to say, government spokesman Steffan Seibert said.
Iran war could cost Israel economy $42 bln Israel’s economy would incur damages of as much as 167 bln shekels ($42 bln) should Israel attack Iran over its nuclear programme, business information group BDI-Coface has projected. Direct economic damage would reach 47 bln shekels, the respected research group said. That would be equivalent to 5.4% of Israel’s GDP last year. Indirect damages would amount to 24 bln shekels a year for three to five years due to the collapse of businesses, it said. There has been an upsurge in rhetoric from Israeli politicians this month suggesting the country might attack Iran’s nuclear facilities ahead of U.S. presidential elections in November.
Israel, widely believed to be the only atomic power in the Middle East, views Iran’s nuclear programme as an existential threat, citing threats made by leaders of Islamist Iran to destroy the Jewish state. BDI noted that 32 days of war with Lebanon in 2006 led to a 0.5% reduction in Israel’s economic growth. Direct costs such as civil property and infrastructure damage cost the economy another 1.3%. “In the event of a war of the same magnitude, duration and damage, it is possible to expect damage of 16 bln shekels,” it said. The war with Lebanon took place mainly in Israel’s north, which produces just 20% of the country’s output.