ECB Press Conference Highlights and Analysis

May 3, 2012

The ECB did not change its key interest rates nor make any concrete announcements regarding non-standard measures to fortify market functionality and the transmission of ECB policy to the real economy.  There was no consideration of a rate reduction at the present time or any other form of stimulus.  The SMP facility remains a possible tool to be used to buy national bonds but hasn’t been used for some time.  A decision on the possible future use of longer term refinancing operations will be made and announced in June.

The ECB kept its baseline view that the euro area economy stabilized at a low level in the first quarter and will recover gradually thereafter, aided by strengthening foreign demand, low short-term interest rates and various other policy means of support for the economy’s functionality.  However, growth will be limited by balance sheet deleveraging, high unemployment, and sovereign debt strains.  Moreover, it’s been observed that April survey information indicating deterioration underscored the high level of uncertainty surrounding the baseline view of positive growth ahead.  By June when new macroeconomic forecasts are to be released by the central bank, the Governing Council will have a better idea from the release of hard data about whether April’s survey evidence has been mirrored by renewed contraction and, if so, whether a modification of the baseline view is warranted.  Risks to the growth forecast understandably continue to be skewed to the downside, while risks associated with inflation are balanced.

The price forecast sees a rise in consumer prices above-2.0% this year but deceleration to under 2.0% by early 2013.  Inflation expectations remain firmly anchored, and the cross-checking monetary analysis that found money growth and credit demand subdued also suggest that price developments are likely to remain in line with the Governing Council’s notion of price stability (below but close to 2.0%) over the medium term.

In the question and answer portion of the press conference, President Draghi on multiple occasions defended the policy stance as already quite “accommodative” as attested by the abundance of liquidity, low historical interest rates, and negative real interest rate levelsHe did not mention the euro’s external value, however, which has generally stayed stronger than most analysts were anticipating.  The euro’s failure to depreciate to softer levels is a contrary indicator, suggesting that ECB policy is not as loose as Draghi would have us believe.

Draghi’s need to defend ECB policy stemmed from his continuing assertion that the ECB has done plenty and that for the dream of “economic and monetary union” embodied in the EMU acronym to be achieved, it will be up to governments to envision a fiscal union in the future and to plan and steer a path toward reaching that goal.  On further inquiry, he did not back away from his recommendation that long-term structural reform and fiscal consolidation now, rather than short-term crisis management even though the euro debt crisis has been festering for 2-1/2 years already.  To prove his point, Draghi cited the success of structural reforms undertaken in the 1980s after inflation and deficit spending spiked in the 1970s. 

The view of the ECB, Draghi and the German government is clearly not accepted by everyone either in Europe or around the world.  Austerity piled on austerity has simply depressed economic growth more and more deeply.  The same approach in the United States is yielding similarly disappointing results, but at least the U.S. has the flexibility to promote a weaker dollar when domestic fiscal restraint is applied.  In the so-called dysfunctional 1970s and 1980s, real U.S. GDP expanded at respective annualized rates of 3.3% and 3.0%, much higher than the 1.7% per annum average pace over the 12-1/4 years since the end of 1999.  The complaint is made that in the 1970s people on fixed incomes saw their savings destroyed by the rising cost of living, but this same classification of households is equally disadvantaged now because of very depressed interest rates.  Indeed, negative real interest rates are common to both periods.  The ultimate question is the one coined by former President Reagan in 1980, to paraphrase “do you feel better off now than 25-30 years ago?”  On both sides of the Atlantic, most people would truthfully answer no.

Draghi also voiced another piece of austerity gospel, that it is better to cut spending than raise taxes and better to reduce current spending than public capital expenditures.  This blueprint has been used in the United States.  The substantial drop in U.S. trend growth since end-1999 and swing from large budget surpluses to massive deficits was promoted by the Bush tax cuts.  The policy gridlock in congress persists largely because Republicans, including their presidential candidate, will accept no deal that includes any rise in taxes, not even a minor reversal of the Bush cuts.  Less realized by the public is the clampdown on government spending that is already well underway.  Public-sector spending rose just 1.2% between 1Q09 and 1Q10 during the first year of recovery, and such then contracted 1.1% in the second recovery year to 1Q11 and by 2.1% in the year to 1Q12.  This grand recipe has fostered decaying infrastructure and kept the jobless rate above 8.0% almost three years into the recovery. 

Draghi’s position on how best to get from current economic conditions to a much healthier state is the orthodox view that’s been pushed by mainstream economists for the past generation.  I would expect he or anyone else in his position of authority to espouse nothing else.  It’s not the view, however, that Keynes held in the 1930s when advanced economies last faced a situation as dire as now, and it isn’t necessarily correct when practiced collectively by every nation at the same time.  The peasants with pitchforks understand this and are getting angrier by the day.

Copyright 2012, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.


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