ECB monetary policy does not work with a broken credit line

2011-12-09

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On December 8 the European Central Bank announced its latest monetary policy measures that aim at easing the liquidity in the banking sector. The package includes a lowering of the main interest rate from 1.25% to 1%, a decrease in the interest rate on the marginal lending facility by 25 basis points to 1.75% and a decrease in the interest rate on the deposit facility by 25 basis points to 0.25%. These measures can be seen as short term policies that can prevent an immediate credit crunch, thus can be considered positive.

Yet the lower interest rates will do little to no good in the liquidity in the real economy, since the confidence in the market in very low. Private banks will use the cheaper money to cover their immediate needs, rather than lending it out, while investors continue to be concerned about the sustainability of the single currency, which prevents them from expanding their economic activities amid this environment of uncertainty.

The credit line in Europe is practically broken, for three reasons: (1) fears about defaults of sovereign states that can lead to bank failures, (2) uncertainty about the capacity of private banks to cope with the mounting pressures due to shortages in their capital base, (3) lack of faith in the very existence of the euro, or of the eurozone in its current form.

All three issues can be tackled at the ongoing European summit, if European leaders can finally produce the sort of “comprehensive solution” they have been promising for months now, without however being able to deliver anything concrete apart from self-defeating half-measures that have been putting more pressure to the collapsing euro edifice instead of supporting it.

The ECB has followed the right path as far as monetary policy is concerned. But we must always bear in mind that the structural flaws of the euro that are at the root of this systemic crisis, will only be addressed by political leaders who will be willing to deal with the problem systematically and decisively instead of hiding behind their finger.