There are obvious difficulties and constraints on monetary policy in the 16-member Eurozone compared to more fully integrated currency zones like the fifty states of the USA, the ten provinces of Canada, etc. But could the lack of integration in the 16-member eurozone be used advantageously for some types of policies?
USA monetary policymakers can also feel hamstrung, not by the lack of integration, but by the extremely high financial market integration across the 50 states of the USA. At times, the state of Michigan is deep in recession with falling property prices, moribund wages and costs, and inadequate demand while, say, Texas is booming with increasing prices and costs and high regional demand. The Federal Reserve has no policy instruments to address both problems simultaneously – buying T-Bills from banks in Detroit while selling them to banks in Houston will have no effect on regional interest rates or credit availability. The extremely high integration of the US financial system means that there is only one monetary policy possible at any time for the entire 50-state system, even when regional economies are out of synch.
This is not true in much less integrated Eurozone financial markets, particularly now that the interbank market is less liquid, and particularly in peripheral markets. The ECB is extremely inflation-averse, and it is true that the core of the Eurozone is not at the moment in need of monetary stimulus. However, some countries in the periphery, particularly Ireland, are badly in need of credit loosening. One of the biggest drags on Irish GDP growth is the current tightness of credit availability for domestic businesses. The ECB has the ability, unlike the Federal Reserve, to implement regional monetary policies, easing credit availability in chosen peripheral markets without impacting the core. Perhaps this is a policy tool which should be exploited more fully.
The large Irish drain on the exceptional liquidity facility at the ECB should be understood as a type of regional quantitative easing. When the ECB accepts repos of collateralized loan assets from Irish banks, the ECB indirectly increases the amount of credit available to Irish businesses through the domestic banks.* As things stand in the interbank market, there is little or no “leakage” of this available credit to the Euro core. It will not cause inflation in Germany, or even in Ireland. It will just improve the dire credit conditions in Ireland.
Perhaps the ECB should be looking toward increasing, rather than decreasing, its exposure to Irish loan assets through its repo operations. Admittedly, the ECB takes on some counterparty risk from this transaction with Irish banks (which is why the transaction cannot be replaced with Euro-area interbank trade) but that should be part of the ECB’s job description. It is the lender of last resort and liquidity provider when market conditions require. Given the eurozone’s lack of full integration, the ECB has the ability to distinguish between core-eurozone credit conditions and regional credit conditions and act accordingly.
* Unless the banks use all the cash received to shrink their liabilities.