Bursting the Bubble

Dovish ECB does not deliver what was expected

9 December 2015 | by

When a country joins a monetary union, it gives up its monetary policy stance that is tailored to its needs, i.e. the level of interest rates and money supply that is appropriate for its economy. The resulting common policy is a one-size-fits-all policy. Booming regions, with high inflation, have the lowest interest rate in the monetary union, thus reinforcing the boom; countries in economic difficulties, with low inflation, have the highest interest rates, thus weakening the economy. Other policies are needed to balance this adverse monetary policy stance. Fiscal policies do the trick but are much weaker than monetary policy and tend to be counter-cyclical than the given cycle: contracting during boom and expansionary during busts.

What happened before

With the Fiscal Compact and the European Semester, the fiscal policy of national member states of the euro zone is under constraints, thus eyes are fixed on what the European Central Bank will be doing. The ECB has only one mandate and that is price stability, i.e. maintaining an inflation of under, but close to 2%. But with asymmetrical cycles in the euro zone, the ECB is running the mean of inflation rates for the euro zone as a whole. At the height of the sovereign debt crisis in 2011-2012, which occurred after the global downturn of 2008-2009, the president delivered a speech that, ‘he would do anything to save the euro’. This lead to the Outright Monetary Transaction (OMT) program in 2012. To ease the markets of government bonds, OMT delivered which means that debt burdens of governments would be manageable. In 2014, with inflation running towards deflation, the ECB announced its program of Assets Purchasing Program or Quantitative Easing (QE), whereby the ECB would monthly buy 60 billion in government assets and bonds of countries in trouble.


On December the third 2015 markets were looking forward towards the statement of Mr Draghi, president of the ECB. This was because of the inflation lacking in the EU as a whole. Core inflation, i.e. inflation without volatile prices of food and energy was 0.1% in November, so everyone thought that the ECB would add more stimulus to its QE program. Instead, it disappointed the markets by doing nothing more in its QE program. ECB only said that it would run the QE program longer than said before – this to March 2017 at least at the normal pace of 60 billion a month.

Draghi stated that QE is needed to bolster economic recovery further. The economic outlook of the euro zone is slowly nearing a recovery, so Draghi has proclaimed that recovery happened because of its monetary policy. However, inflation rates diverged between the core and the periphery of the euro zone, with the periphery having lower inflation rates as the core. Additionally, Greece has even stumbled into deflation. Draghi went even further and announced that the ECB would buy debt from communities and cities for the first time, using such bonds it had bought, when matured, as a reinvestment to buy more assets.

The other action it did immediately was lowering its deposit rate to -0.3%. This is the rate the banks get if putting money in accounts of the ECB, which was less than expected but will have repercussions on EU banks: as expected, banks will lower their deposit rates further, which mean that savings will earn less.


Markets that had expected that the ECB would do more lost 2%. Markets expected that the ECB would create more money whereby the euro would have lost value. This would drive exports and growth, yet with the loss of euro value, imports would become more expensive, which would lead to more inflation, which is the mandate of the ECB.

That the markets were disappointed that the ECB did not do anything more, can be attributed to the vote in the Governing Council. Every monetary decision of the ECB has to be put before a vote, at which every central banker of the euro zone sits with one voice. Decisions must be reached in consensus, yet this was not the case. Jens Weidmann, President of the Bundesbank, who has been against more monetary stimulus, was against the decision. The reaction of the Bundesbank is based on history, and has always been against more monetary stimulus because it pushes inflation. The ECB, which mostly follows its biggest member, had no choice whilst the euro appreciated against the dollar in reaction.


Monetary policy is focused on maintaining price stability over the medium term and its accommodative stance supports economic activity, but not enough. In order to reap the full benefits from the monetary policy measures, other policy areas must contribute decisively. The swift and effective implementation of structural reforms, in an environment of accommodative monetary policy, will not only lead to higher sustainable economic growth in the euro area, but will also raise expectations of permanently higher incomes, accelerating the beneficial effects of reforms, thereby making the euro area more resilient to global shocks. Fiscal policies are too constrained to work due to the Stability and Growth Pact. However, the euro zone is going through a slight recovery, which means that the policies put in place, are the right ones for now but this is not enough. Furthermore, the worries are not over because of the slump of the world economy, especially in emerging markets and geopolitical stress in the world: the conflict over Ukraine with Russia and the fighting in the Middle East.

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