Central Banks on the Offensive?

By Jean Pisani-Ferry

FRANKFURT – It looks like a coordinated offensive: on September 6, the European Central Bank outlined a new bond-buying program, letting markets know that there were no pre-set limits to its purchases. On September 13, the United States Federal Reserve announced that in the coming months it would purchase some $85 billion of long-term securities per month, with the aim of putting downward pressure on long-term interest rates and supporting growth. Finally, on September 19, the Bank of Japan declared that it was adding another ¥10 trillion ($128 billion) to its government securities purchase program, and that it expected its total holdings of such paper to reach about $1 trillion by end-2013.

There is, indeed, room for such concerted action, as the outlook for all three economies has deteriorated significantly. In the eurozone, GDP will certainly decline in 2012, and forecasts for next year are mediocre at best. In the US, output continues to expand, but at a moderate 2% pace; and, even leaving aside the fiscal cliff looming at the end of the year, when Congress will be forced to impose spending cuts and allow tax cuts enacted in 2001 to expire, recovery remains at risk. In Japan, the global slowdown and a stronger yen are hitting the export sector, growth is flagging, and inflation is close to zero again.

The reality, however, is that there is no common stance, let alone a common plan. In the strongest of the three economies, the Fed is willingly risking inflation by pre-announcing its intention to keep the federal funds rate at exceptionally low levels “at least through mid-2015.” In the weakest of the three, by contrast, the ECB has no intention of boosting growth through quantitative easing or interest-rate pre-commitments. On the contrary, the ECB is adamant that the only aim of its “outright monetary transactions” (OMT) program, which will buy distressed eurozone members’ government paper, conditional on agreed reforms, is to contain the currency-redenomination risk that contributes to elevated interest rates in southern European economies. The goal is to restore a degree of homogeneity within the euro area in terms of the transmission of monetary policy. All of its asset purchases will be sterilized, meaning that their monetary-policy effects will be offset.

Furthermore, given the controversy that its announcement of the OMT program has incited in Germany – not least with the Bundesbank – the ECB would certainly be discouraged from pursuing any Fed-like effort to push for lower interest rates along the yield curve. To ward off an offensive by German (and other) monetary hawks, who maintain that the ECB has opened the door to debt monetization, the Bank is bound to err on the side of orthodoxy in the coming months. The more its unconventional initiatives to repair the euro are contested, the more orthodox the ECB will be in its conduct of monetary policy.

This discrepancy between the US and Europe is not good news. For the eurozone, it implies a strong exchange rate vis-à-vis the dollar (and, by implication, the yen, as the Bank of Japan closely monitors the yen-dollar exchange rate). But countries in southern Europe, especially Spain, need the support of a weak currency to rebalance externally and return to current-account surpluses. Absent this helping hand from the exchange rate, all southern European rebalancing will need to take place internally through domestic deflation, which in turn risks jeopardizing their return to public-debt sustainability. So the way out of the European conundrum – currency depreciation – risks being blocked by the market’s perception that the ECB and the Fed are at odds over monetary policy.

True, crises in problem countries and doubts about the euro’s viability could weigh on the common currency’s value. But it is worrying that the solution to Europe’s internal imbalances hinges on the continued unfavorable perception of the eurozone’s ability to address its problems.

Seen from the rest of the world, things are not much better. Guido Mantega, the Brazilian finance minister, was quick to dismiss the Fed’s stance, again warning of “currency wars.” This reading overlooks the fact that currencies throughout the emerging world ought to appreciate vis-à-vis those of the advanced economies, simply because the emerging countries do not face the same economic challenges. The US, Europe, and Japan are all burdened by high levels of public and private debt, and are caught in long, painful, and hazardous deleveraging cycles that render recoveries feeble and vulnerable. By contrast, emerging economies suffer from a downturn, but their situation is fundamentally sounder, which should be reflected in the value of their currencies.

Unfortunately, the combination of aggressive easing in the US and a much more guarded attitude in Europe obfuscates the message. It suggests that the issue for the global economy is that the US is trying to find a way to inflate its problems away. That may be true, but it should not be permitted to obscure the underlying structural problem that the world economy is facing.

The recent moves by the ECB, the Fed, and the BoJ look like concerted action. Sadly, just the opposite is true.

*Jean Pisani-Ferry

Jean Pisani-Ferry is Director of Bruegel, the Brussels-based economic-policy think tank, and Professor of Economics at Université Paris-Dauphine. He was an adviser to the European Commission’s

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