The European Central Bank will maintain its accommodative monetary policy for a long time period because imbalances in the euro zone cannot be reduced rapidly. In addition, it will adapt its asset purchases to market conditions.
The first aspect is recurrently developed by Mario Draghi. He wants to convince all stakeholders that the European Central Bank will maintain all the measures taken to the end. Expectations that the current monetary policy stance could not go to the end must converge to zero, that’s Draghi’s message to keep the ECB credibility intact. In other words, even if the results improve on the business level, GDP numbers for the first quarter were strong, the ECB will maintain its very low-interest rates for an extended period, the TLTRO will continue until June 2016 and asset purchases will go until September 2016 at least.
The ECB strategy is to assume that changes in behaviors, investors or economies, will take time. Monetary policy should maintain its grip to allow the economy of the Eurozone to find a more balanced position than that observed in past 4-5 years during which growth in activity was nil and inflation has converged 0%.
The main issue and challenge for ECB is there.
The economy must converge to a stronger profile; that’s the main reason for ECB rates at the zero lower bound for an extended period and the will to flatten the entire yield curve.
This should drive down the euro and enable the economy of the area to find a more robust dynamic activity. But this change must be perceived as durable and as a consequence long-term expectations must change. But this will take time. That’s the reason why the ECB must have a long-term strategy.
Entrepreneurs need this new framework to imagine that the current conditions will continue, thereby encouraging them to implement investment plans. Improvements in the Euro business cycle will go only through higher investment.
The other challenge is to influence the long-term the inflation expectations to sustainably avoid the risk of deflation. On this point, the ECB regularly presents a profile of long-term inflation expectations and their possible long-term convergence to the 2% target.
The ECB wants to readjust the economy of the euro zone on a path that is not the one that has been observed for several years. The two successive crises seen in Europe brought the dynamics of the Eurozone out of the framework seen before these crises. The rupture was sufficiently strong and persistent that the convergence to the former framework was not possible.
The ECB expects, by its voluntary and proactive monetary strategy, to change the current setting and converge to a new one. It will not be the pre-crisis framework because everyone agrees on the fact that potential growth will be lower in the future. It must define a more robust framework in order to produce higher incomes and jobs than that resulting from the sovereign debt crisis and austerity policies.
The remarks earlier this week by Benoit Coeuré on the modulation brought by the ECB in the profile of its purchases in order to adapt to market conditions and profile of broadcasts made by States show that to increase the credibility of its policy, the ECB must be more active to maintain its grip.
Monetary policy in the Eurozone frankly changed during this crisis. It has now a long-term goal but must remain very active in the short-term. To emphasize this dynamic would not it be efficient to have a more active and targeted fiscal policy? A higher growth trajectory would be easier to attain with two arms instead of one?