Regional Quantitative Easing in the Eurozone

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.

30 thoughts on “Regional Quantitative Easing in the Eurozone”

  1. @ Gregory

    “The large Irish drain on the exceptional liquidity facility at the ECB should be understood as a type of regional quantitative easing.”

    Woh, careful there. I believe i suggested this about a year and a half ago and a lot of people went ballistic at the concept…

  2. Gregory Connor writes:

    One of the biggest drags on Irish GDP growth is the current tightness of credit availability for domestic businesses…

    [CG dons advocatus diaboli cap]

    Sorry, but I’m a bit confused about the chain of causality here. One might as well have argued the other way round — credit is tight because there is little hope that the economy will grow, and if banks are retentive today it is because they were far too fluirseach in the good old days avant le deluge.

    Or is this just more second-guessing on the part of the ivory tower community? E.G. banks were THEN irrationally exuberant but NOW they have gone to the other extreme and won’t take the sound advice of the Krugmanites who can spot a good business plan from outer space.

    An ‘inner voice’ tells me that many of our domestic businesses are seeking credit just to stay above water and postpone their extinction for another few weeks or months — just like the banks, they are keen to mark their assets to fantasy rather than to the market. That’s why we have this ‘current tightness’.

  3. From my perch here in the US QE has had little effect on the real economy other than lowering mortgage rates. However, this has not benefitted as many as had been hoped because too many people have no equity left in their home and thus cannot refinance or have otherwise impaired their credit
    via credit cards, job loss, wage reduction etc.

    The real benefit has gone to high income brackets who can take advantage of lower mortgage rates or have benefitted from a phony stock market rally.

    The drag of underwater homeowners and soaring bank repossessions of homes putting more homeowners underwater cannot be cured with QE and I gather this is also a problem in Ireland with, perhaps, not yet the number of bank foreclosures but with a huge amount of ‘shadow inventory’.

    I suspect that is why the ECB/EU decided to make your NPRF recapitalize the
    banks so as to make Irish money take the first loss should homeowners decide to throw in the towel and either walk away from their mortgage or just
    stop paying. Diabolical IMHO. At least an American who walks away from a bad deal doesn’t feel he is letting his country down. His mortgage was securitized and could be owned by Deutsche Bank or UBS as easily as Bank of America or Wells Fargo.

  4. @ScottinFlorida – “and either walk away from their mortgage or just
    stop paying”

    Unfortunately, with the type of mortgages we have over here, you can never walk away from them. Even if the bank repo your house, they chase you for life for any balance due to them once it is sold and the mortgage partially repaid (after deducting tons of charges and interest of course).

  5. @ScottinFlorida

    Joseph is correct — the USA mortgage law (particularly in some non-recourse states including Florida) and US bankruptcy process are very different from in Ireland where a residential mortgage, like a marriage, is for life. Incidentally, note that Joseph uses the abbreviation “repo” to mean repossess not in my earlier sense of repurchase agreement.

  6. @Bond.. Eoin Bond

    Sorry if I stole your idea – I do not remember your specific comment but cannot swear I did not see it since I do read the blog. Maaybe it influenced me so apologies if I did not give credit where it is due. The general idea that the ECB repo faciliity (especially regarding NAMA bonds) is a type of QE has been floating around a bit — adding the US-Eurozone comparison and regional monetary policy aspect were my new twists.

  7. That maybe true ( and it is true in the US in many cases as well) but having a court award the bank a deficiency judgement for an unpaid mortgage is not
    the same thing as having a performing loan. They have a property that is worth far less than the outstanding balance on that loan and that is the issue.

    With the unemployment rate what it is in Ireland and ‘austerity measures’ that are in place or soon will be, to include reductions in social assistance from your government, how many homeowners are going to be unable to continue to make their mortgage payments? I’m with Morgan Kelly on this one. I think you are going to see many more defaults than you have as people just can’t afford to make the payments or grow weary of the struggle
    doing so on a property that is worth less than the loan.

  8. Pennies from heaven?! The FF talking point about how the ECB will pay for NAMA was widely ridiculed at the time, but now seems to be rapidly becoming consensus.

    Gregory Connor wrote: “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.”

    Taking credit risk certainly isn’t part of the ECB’s job description, nor should it be. That’s the realm of the fiscal authorities. People seem to have appropriated the ‘lender of last resort’ function to mean whatever they want it to mean. Of course, in a crisis, definitions get stretched, but the idea that a lender of last resort should keep an insolvent banking system on semi-permanent life support is an absurdity. You propose borrowing 80% of GDP at low rates against awful collateral for years on end, and want to pretend that’s the rightful function of a Central Bank?

    We can’t advance the debate by advocating magic bullets and pie-in-the-sky solutions. More than ever, now is the time for sobriety and realism.

  9. @ Gregory

    i didn’t mean it in an accusatory fashion! I think it was an anti-Nama response at the time, whereby lots of people who were against Nama didn’t like the suggestion that it was, directly or indirectly, creating a form of QE for Ireland, as this may mean that it actually had some ‘good’ characteristics (regardless of whether it actually managed to get credit flowing again). The entire loosening of the ECB’s collateral framework represents a form of QE-lite, albeit one which has turned out to be far too weak to solve the EZ’s now obvious problems. Full on QE, regional or pan-Euro, is now what it is required.

  10. @Gregory/Scott – “note that Joseph uses the abbreviation “repo” to mean repossess not in my earlier sense of repurchase agreement.”

    I once watched an American film called ‘Repo Man’ about a guy who went around repossessing things from people who had fallen behind on their payments (I’m sure there’s a joke there). As I was making a comment to an American I thought that….. never mind.

    I don’t get out much.

    I’ll just get my coat.

  11. I’m afraid that all this is going to be quite irrelevant, and possibly very soon. And I have to admit that, rational or not, and with great trepidation, I am looking forward to the whole edifice of the Euro collapsing.

    I believed in the Euro, and I believed in Europe, but I can’t help feeling that now only a complete catastrophe will make all of us in europe – and the world – face up to the reality that the banking crisis is already at the core of europe and possibly the world.

    We are waiting for the tipping point to be reached. Then there will be clarity as we stare into the abyss. Well, either clarity or the abyss.

  12. Gregory Connor is correct about the need for QE in certain parts of Europe but I do not think that the (lack of) market integration argument is necessary. Because the ECB is now engaged in supporting sovereign debt prices, it’s support is automatically targeted to those regions with problems (and pressure on sovereign bonds). Moreover, it’s general commitment to supporting the banks will be targeted to problem regions because banks in those regions will have liquidity problems.

    As regards the lender of last resort (Other Andrew), of course it cannot involve an open-ended commitment to bad banks. But it should involve a commitment to support while a bank resolution scheme is put in place. But there is no evidence that the ECB encouraged the Irish Government to change its bank resolution scheme before it threatened to pull support a few weeks ago. This is what shook the system (and the Government). These discussions should have been held privately, instead of telling the markets that is was “frustrated.”

  13. Federations like Canada made up of ten Provinces (Lander) and two Territories and being in existence like Germany for over a century have a multitude of complex agreements that keep the show on the road. The state is supreme in areas such as Defence, Foreign Relations, External Trade, Constitutional and Criminal Law, Central Bank. Shared areas are Income Tax, Corporate Tax, Inheritance Tax, Health Care. Post Secondary Education. The Provinces are creatures of the Federal Gov’t and the Cities, Towns, Area (regional) Govt. are creatures of the Provincial Gov’ts. Property taxes are exclusively at the City, Town, Regional Gov’t level, they set the rate and collect the taxes. Some sales taxes are also set and collected by lower levels of Gov’t. Changes to the arrangements are by agreement between the federal gov’t and the provinces collectively, there are opt out arrangements in the event of disagreement. Federations are an extremely complex form of gov’t yet they do pass the test of time. In a nutshell they evolve to meet current conditions. The exception is the USA which has deified its Declaration of Independence and Constitution leaving itself stuck with ideas that were relevant in the 18th century. This is probably due to the religious leanings of its founders who fled England in order to practice without hindrance. The EU has demonstrated that it is capable of adapting and as long as that attitude prevails it could last longer than the Roman Empire.

  14. Garry O’Callaghan, my reading is that the ECB were not acting precipitously. They have long signalled their intent to wind back extraordinary liquidity provision; at the very least, these fixed-rate, full allocation tenders were on the way out. This has been communicated loudly and clearly numerous times. Also, it seems that there has been an element of moral suasion by the ECB, communicating via the national CBs, asking the banks to reduce their reliance on ECB extraordinary funding. Evidence for this can be inferred from the relatively restrained bidding at recent LTROs, and by public comments with regards to the problem of addict banks. Other countries, most notably Spain and the core, did indeed go down the route of reducing their reliance on the ECB, but Ireland’s borrowing has been surging in recent months…either they didn’t get the memo, or, a more reasonable surmise, the system was collapsing…which seems like a good time to call in the IMF et al.

    To me, the ‘ECB pulled the rug from under us’ is just FF spin. There was no plan…the NAMA bonds could only ever be parked with the ECB, despite clear signals even at the time that the program under which they were parked was of limited duration. So BLTD’s cunning plan was more can-dribbling than can-hoofing.

  15. How about a kind of QE for the virtuous where a way is found for the new money to be fed into the banking and financial systems of Germany and the “saver” states in proportion to how solvent they are? It would be a kind of retrospectively applied interest on deposits or sovereign wealth funds.

    You get a kind of variable inflation with less effects on those who avoided the crisis (Germany, Austria, Sweden – basically anywhere with a lot of blonde people) while the debts (and savings) of those in the PIIGs are reduced in value.

    The euro is worth less making debts less onerous and defaults more acceptable while the Germans and Scandinavians find themselves comparatively better off making the inflation politically acceptable in Munich.

    It is as least as plausible as the English Telegraph’s idea of Germany leaving the Euro.

  16. Other Andrew,

    The exit strategy was indeed well signposted, but some Council members began to express frustration when the policy was still in place (e.g. Nowotny). As a result, people looked at where the liquidity was still required (Irish banks) and got nervous. There should have been a combined communique saying that the ECB was satisfied (after consultation) with plans to resolve Irish banks but would otherwise seek to reduce the non-conventional measures. (Another example of a lack of euro wide procedures).

    If you look at Central Bank data on the banks you will see that deposits rose in the Spring and reliance on ECB waned. The increased ECB exposure in the Summer was due to bond repayments while deposits were still on the rise. But it was known beforehand that there would be a need to repay bonds (see IMF Staff Report from June) so it should have been planned for. Then, in September, after the frustrations were expressed, deposits fell by €34 billion.

    I can eagerly agree that our bank resolution was too slow, but this is no excuse for ECB Council members expressing their frustrations. They should have come to the Government very directly and quietly first. Whatever you (and I) think of the botched bank resolution, it is far too dangerous for ECB Council members to mouth their frustrations like this. And they did cause a serious problem.

  17. There is little prospect of the ECB easing on a regional basis. The fact is that the Eurozone has never operated as a source of liquidity due to its legacy Bundesbank philosophy. Only now in the Euros first serious crisis due we see easing emerging as a policy option albeit with reluctance on the part of the Germans. A reluctance that will see the Euro die if someone does not explain it to them. As you say it is liquidity that is needed not fiscal rectitude right now.

    In the case of the Fed we are seeing easing that is actually having the desired effect. The money is finding their way to the more productive elements of the economy not just being soaked up by the banks. Although wait and see is the operative phrase on this.

    In Ireland we are stuck in the EZ and must think of some imaginative ways to create liquidity in the economy. One suggestion might be the creation of a State credit agency (bank) which issues credits to communities, local authorities and businesses. These credits would be in the main electronic transactions ie loans, which would be repayable electronically and carry an interest payment of say 5 percent. The issuance would need to be electronic and would need to stay that way ie, everyone getting payed keeps the transactions involved electronic – does not cash out in Euros- thereby avoiding the Euro clearing system. When these loans are payed back the “capital” involved is re issued and the interest payment is effectively a dividend to the government. Had we our own currency the cost of printing would be deducted and the rest passed on to the government.

    Banks could get involved too after a time. The key here would be to not permit foreign (EU) banks operating in competition with the state agency.
    These banks would be at a huge disadvantage and we would fall fowl of EU competition laws probably. At present there are no EU banks operating here except Rabobank (someone confirm this?) which is an online operation. Our nationalized banks would need to be brought to heel. Deposits of these credits (through Paypath or the equivalent) would need to be 100 percent reserve deposits and not issued out as loans. ATM’s could only be used for the payment of bills (ESB, or whatever).

    The issuance could be for as much as is necessary to restore the nearly fifty percent reduction in the money supply since the crash. The proviso would be – that when funds percolate into the pockets of wage earners the credits are card based, not in cash. Retailers that accept the credits will need to provide card reading facilities for the purpose.

    There is enormous pent up demand for credit at present that is not being met. This could be the mechanism that satisfies that need. As well as funding for those institutions protecting the vulnerable in society we would be stimulating were it counts at the entrepreneurial level.

    Interest can form up to fifty percent of the costs in public projects. Because the credit issuance costs practically nothing we would be saving the country a fortune.

    Credit is too important to be left in the hands of the International Banking Cartel. In this case the productive capacity of the economy would be backed by the Nation in the form of these credits. This idea would get the economy going again.

  18. Just correcting something just stated… we would not be permitted to exclude any Euro bank that wanted to set up here.

  19. “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.”

    Hmm, I can see why the interbank market isn’t functioning in terms of money flowing into Ireland but what’s to stop it working for money flowing out of Ireland? In other words, why would Irish banks tapping ECB credit lines lend into the Irish economy rather than just, say, buying German bank bonds?

  20. Also, i know this is a minor point at this stage, but in the context of Eoin Bond’s call for ECB QE, the ECB hasn’t even exhausted conventional monetary policy – the policy rate stands at 1%. I seem to remember a year or two ECB officials were offering the nonsensical argument that they were holding onto these 100bps because if they wanted to keep their powder dr in case things got really bad….

  21. This article makes a very interesting point and it is obvious that the Central Bank in Dublin played a part in helping this through liquidity operations. But I don’t think it is correct to call this QE. The risk on the assets used as for repo stays with the banks that have to buy them back at the set price. In the US, the Fed has bought and is buying assets to go on its own books. The ECB should do the same in much larger quantities than it has done so far. There are two reasons to be hopeful that it will.
    First, the very large repo operations it has undertaken involve risk to the ECB balance sheet anyway. If the ECB were an investment bank it would have radically reduced the amount it was prepared to lend against this collateral. So it has an interest in ensuring it maintains value.
    The second is that the crisis has spread closer to the core. As long as the crisis was restricted to the PIGS or the PIIGS, it could be treated as a purely regional problem. But now places like Belgium are suffering. This increases the political constituency for policy easing. The markets have taken Trichet’s comments as a promise of action. The more it can be focused in places which need help most, the more effective it will be.

  22. @David Blake

    I agree that repo by the ECB of collateralized loan assets isn’t “real” QE since it only provides relatively short-term liquidity funding. It would be better if the ECB would commit to keeping the repo facility open so that the banks could be sure that they would have continued access to the funds. In that case perhaps the repo facility could be viewed as more of a reliable medium-term source of funds for the banks. I do not think that the ECB is prepared to purchase collateralized loan assets outright with no recourse, which would be “real” QE.

  23. Greg, maybe the Council just might listen to you http://imarketnews.com/node/23229 “One option would be to introduce a two-tier system in which weak banks could still receive unlimited 3-month funding in separate operations, perhaps at a penalty rate. Another option would be for national central banks to provide emergency credit lines as Ireland’s central bank did recently for Irish banks and the Bundesbank did for Hypo Real Estate in 2008.”

  24. Is the ECB’s insistence on pushing Ireland to avail of the EU/IMF fund not directly derived from the Irish banks over reliance on ECB funding?

    It would be a signifcant u-turn of ECB policy if it was to suddenly shift from a policy of trying to wean ‘addict banks’ off their funding to begin accepting a broader scope of loans from the same banks.

    Karl Whelan highlighted this issue a long time ago where nobody else seemed to notice and I think his post here:

    http://www.irisheconomy.ie/index.php/2010/10/10/the-irish-banks-and-the-ecb/

    seems to have been born out. It would take a radical shift for the ECB to introduce measures akin to those which you propose however these are radically changing times….

  25. Gregory,

    Thanks for a thread on this. I don’t think your suggestion goes far enough.

    Although I blame Irish government for not controlling the explosion in private sector credit (and it’s probably more appropriate to say they encouraged it), the ECB also bears responsibility. The ECB set interest rates suitable for Germany and did nothing to restrain credit growth in the PIIGS (well, Ireland and Spain, it could be argued that the other countries have different problems) Lenihan compounded our problems by his blanket guarantee. It is important to note that some of the biggest beneficiaries of the Irish taxpayer have been German investors. Again this was enabled by the ECB’s emergency liquidity operations. Only after the passage of foreign funds had occurred, did the ECB seek to remove this facility.

    Will the current EU-IMF programme work? No. By 2014, we’re looking at a country with about 120+% debt to GDP, a budget deficit of 3+%, 25% of government income going to service debt and a pretty crap credit rating.

    Therefore Ireland needs to deleverage. Burning bank bondholders is not as attractive as it was (there isn’t enough unguaranteed available). A sovereign default is an option, but one with many nasty consequences. Debt forgiveness would be hard to sells to other countries.

    My own humble suggestion is here: http://www.irisheconomy.ie/index.php/2010/11/22/bondholders-and-restructuring/#comment-96272

    So rather than a debt write-off, the accessing state pays zero interest but ¾% principal repayment per annum. When the state repays enough principal, they should be in a position to refinance to private investors. Hopefully the repayment element would limit inflation. It gives the PIIGS a route back to health, without overt debt forgiveness. Although it sometimes seems that the Germans would prefer austerity, it’s not necessarily in Germany’s interest.

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