Home > Uncategorized > A Post-Keynesian ECB, Part II

A Post-Keynesian ECB, Part II

From: Erwan Mahé (guest post)

In our latest Thaler’s Corner, last Friday 6 June, we examined the impact of the ECB’s lowering of benchmark interest rates (see PDF, attached), but, as we pointed out, that was hardly the only noteworthy decision the central bank made last Thursday! Today, we will explain how these measures make perfect sense when taken together and how they flow directly from a programme based on the principles of a modern currency. We leave aside for the time being its role of fiscal watchdog that it persists in playing, although such a role does not fall within its mandate and is totally counterproductive. Before going into these points, I would just like to comment on the latest statement by Bank of France chief and ECB governor, Mr Noyer, this Monday in Montreal.

ECB Noyer: Liquidity Regime Off-Balance Sheet Equivalent To QE

Although he is perfectly correct about the liquidity injections into the system, Mr Noyer seems to have (purposely) forgotten two totally different aspects of the ECB’s workings. In the first place, whilst the Fed arbitrarily decides the amount of excess reserves to be created, amounting to the pre-announced totals of its QE programmes, the ECB leaves it to the private sector to work this out. The growth in liquidity is totally dependent on the flows (MRO + TLTRO – reimbursements) of borrowings contracted by commercial banks with the ECB. This is a good thing because it leaves it up to the private sector itself to navigate its demand for money, based on its demand and whims. Second, by offering surplus liquidity to banks on the cheap (0.15% for the MRO, 0.25% for the TLTRO), the ECB allows investors to carry out transformation carry transactions themselves, instead of taking this money from private sector pockets. The “tax” aspect, with its deflationist consequences, that we have repeatedly examined in our analyses of the QE programmes in the US and elsewhere, is thus not present in the eurozone, which is no small point, given the absolute imperative to fight against a deflationist spiral. I am convinced that Mr Noyer and his colleagues are perfectly aware of these differences, but communicating on the matter is not an easy task when some individuals in various countries were only recently declaring themselves to be “enemies of finance’”

Now, let’s take up the ECB’s latest measures.

The end of the SMP sterilisations

This decision is the easiest to examine. We denounced from the beginning what we termed the farce of the SMP weekly liquidity sterilisations at the time of the mini-QE liquidity injections. The ECB intervened at the time on sovereign debt markets to fight against what it called unhealthy imbalances. They were anything but enthusiastic about these moves since they threw in the towel shortly thereafter and let the politicians tackle the problem, which resulted in the highly controversial haircut on Greek sovereign debt in 2012. In order to obtain the backing of certain ayatollahs of “money supply”, the ECB decided that the excess reserves created by purchases of sovereign debt would be sterilised each week via special tender calls. The decision to put an end to the sterilisations will automatically increase the amount of excess reserves in the system by €162.5 billion. Excess reserves peaked to about €800 billion during the 2012 VLTRO launch and have contracted to about €100 billion since March 2014, as banks paid them back, which is well below the €200 billion needed continue to exert downward pressure on the eurozone’s overnight rate, the Eonia.

As a result, the upcoming orchestrated surge in excess reserves to about €265 billion, combined with the cut in the depository facility rate to negative -0.10%, has already pushed the Eonia to historic lows, to below 0.06% this morning (09/6/2014, M.K.)!

We are thus witnessing the success of a coordinated action, both in price (lowering of benchmark rates) and volume (injection of extra liquidity), in order to bring about a general collapse of the short-term yield curve. It is also worth noting that the 2-year German bund has stabilised at around 5 bps, and that these moves have also brought massive help to short-term peripheral nation bills where rates have plunged between 40 and 60 bps in the last month. This lowering of interest rates has simultaneously achieved various goals:

–          It offers a huge breath of fresh air to the peripheral nations, where interest costs will automatically decline, which will thus ease their budgetary constraints and improve their debt profile and servicing of debt-to GDP.

–          It strengthens P&L of these peripheral nation banks, which are the main debt holders. And it could not come at a better time (AQR).

–          It allows for an automatic lowering of interest rates to the real economy, as the resource costs of banks decline at the same time.

–          It accentuates the “yield chasing” or “hot potato effect”, propping up the prices of all financial securities (inducing a wealth effect), thus resulting in a lowering of the capital financing costs for businesses. In the meantime, banks benefit by placing their COCOs at lower and lower rates.

In order to make sure these measures do not appear overly concentrated on financial markets, the ECB announced other measures, the first of which, the TLTRO (Targeted Long Term Refinancing Operation), immediately caught people’s attention. We have been advocating this measure for a long time, but the consensus only recently shifted in favour, and the move to implement it so quickly, in the midst of the AQR and stress tests, caught a number of commentators off guard.


For those interested in the technical details of this measures, check out this link for more information. It suffices to know that this TLTRO will enable banks to obtain financing with the European Central Bank at a fixed rate for the period, amounting to the refi rate at the time they take they loan plus 0.10%, which today would amount to a total rate of 0.25%.

The two first TLTROs will be launched in September and December 2014 at a 2-year maturity. But the originality of this measure, which is the equivalent of the previously mentioned British FLS, is that, if these banks increase their net lending to the eurozone non-financial private sector, they will not only be able to renew said operations each quarter until June 2016, they will also have until September 2018 to pay them back. This means that, under the best case scenario, they can be assured of obtaining financing very cheaply on maturities as long as four years.

It is easy to imagine the attractiveness of such a measure from the standpoint of the safety of their assets-liabilities management and thus the ability to avoid maturity mismatch problems in their balance sheet. The peripheral nation banks will obviously be the main beneficiaries of this system, which will also be a huge aid in restoring the monetary policy transmission channel in these countries!

It is also worth noting that the ECB excluded mortgage loans from this programme, reportedly at the request of Germany, which continues to fear a real estate bubble (???). If that’s all it takes to win over our German neighbours, it’s a small concession. Bear in mind that even the BoE ended up excluding mortgage loans from its own FLS programme. No small point, let’s not forget that the €400 billion (or more) of liquidity thereby created will also put downward pressure on short-term rates on the eurozone and, with it, all the ensuing phenomena examined in the preceding section!  However, and this is something that is still underappreciated by the austerity fans in our central bank, we must not confuse price and volume effect.

Whilst the beneficial price impact from such a measure is undeniable, since it makes it possible to lower interest rates on loans made to SMEs, the overall volume of these loans will depend on the demand from these businesses. This demand for loans depends directly on the economy’s aggregate demand. As it is, given the demand from the public sector in contraction, due to austerity measures, and a still high euro (thus low foreign demand), the entire responsibility for economic growth falls on the shoulders of the domestic private sector. Given the state of the labour market, that makes for one heck of a bet.

The easing of collateral criteria

This is one of the most appetising measures unveiled after the ECB’s monthly meeting, which, for some strange reason, was completely ignored by analysts. In the architecture of a modern currency where loans granted by commercial banks make deposits, which in turn circulate more than imperfectly as a result of the death of the unsecure interbank market, have no other solution besides going to the central bank to balance their balance sheet. Traditionally, in the refinancing operations proposed to commercial banks, central banks only accept the highest quality collateral, generally speaking, sovereign debt with minimal haircuts.

Given that the ECB is trying to push banks to favour loans to the real economy in bank balance sheets, it is perfectly normal that it broadens the scope of eligible collateral used in these operations, preferably, with the least penalising haircuts possible. We therefore view this a very good measure. We pointed toward this approach in the Thaler’s Corner of 12/04/2012 (Who are they kidding? Is the Buba truly independent?), after Mr Noyer stated, in response to a question about one of the first easings of collateral criteria, that “believe me, we can go a much farther”. I am therefore not only surprised about the small notice this measure has attracted, but also by the ECB’s own discretion on the matter, as if it were ashamed of the work it is doing! As you can see in this link, it did not even display the decision on its own site.


And yet, Mr Draghi clearly stated at his press conference:

In addition, the Governing Council decided to extend the existing eligibility of additional assets as collateral, notably under the additional credit claims framework, at least until September 2018.”

To conclude this section, although I mentioned this at the beginning of this newsletter, I think it is worth repeating that the absence of a QE is good news.

No QE and ABS programme

Some will say that I take a malicious pleasure in presenting a contrarian stand, but despite the new consensus view, I consider the absence of a QE in the ECB announcement to be very good news. As I have endlessly stated in this and many other Thaler’s Corners, the QE acts as a tax on savings investment. It only makes sense if, like in the United States, it is accompanied by a counter-cyclical budget policy (expansionist in the case of a recession). Of course, such is not the case in Europe.

Again, this distinction between the real economy and government spending makes little sense. Just ask a barber or hairdresser with lagging sales if they refuse money from civil servants (teachers, healthcare worker, police officer, etc.) because their pay does not come from the “real economy”. For the same reasons, I hope that we will not see an ABS purchase programme and that the private sector will see to the compression of spreads on the sector as we await the easing of regulations where needed.


That’s all for today.

  1. June 12, 2014 at 5:20 pm

    I wonder in which country, police officers and Health care workers are not thought to have real jobs. On the other hand, most often being paid with tax Money there is the risk of having excess personell in these areas just because taxing is mandatory and tax evasion is punishable by law except when supported by highly paid lawyers.
    There is more often the risk that public servants replace Health care workers with administrative staff in which case you have excess overhead. Sooner or later these administrative tasks end up being coffee breaks, or what is called free riders with University degrees. It risks inbreeding, and more administrative staff.
    This brings the idea of preventive work into mind. How many Health care workers or police officers are needed if people are healthy or do not commit crimes? How many administrators are needed if all this work is done by the Health care workers themselves?

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