The Current Path of ECB Policy
While the ECB keeps talking about what it might possibly do, its actual policy choice is a rather odd mixture, as Sharmila Whelan of Asianomics recently pointed out. On the one hand, it is evident that a policy of internal deflation has been embarked upon in the euro area.
However, on the other hand, this is combined with a policy of “pain avoidanceâ€, which we can see by the frequent reactive ECB decisions to temporarily inject liquidity again with instruments such as its LTROs (and their new bastard child TLTRO) and keeping administered rates at ridiculously low levels, as well as by the continued increase in government debt. As we have previously noted in these pages, to the extent that credit expansion has taken place in the euro area in recent years, it has been focused almost exclusively on the funding of more government spending.
The private sector by contrast continues to slowly deleverage (see our previous article “Euro Area Credit and Money Supplyâ€, which contains a recent update of the most important data points in this context).
Naturally, this combination of policies makes little sense, as it simply serves to prolong the pain of the adjustment. If the ECB and other policymakers in Europe were to let market forces make short shrift of the remaining bubble activities in the euro area, there would be a sharp, but short recession. This would indeed be quite painful, but it would also lay the foundation for a sustainable upswing. However, one would have to be politically prepared to endure the considerable short term pain associated with this approach, and a great many impediments to price and wage adjustments would have to be removed beforehand.
The current period of relative calm is likely to soon give way to a more “interesting†time period again, in the Chinese curse sense. This is so, because money supply growth in the euro area is recently decelerating significantly.
