Why has the ECB allowed monetary policy to tighten in an economic crisis?

7th February 2013 by The Harried House Hunter

Today is one where central banks will take centre stage. In the UK we have not only the monthly meeting of the Monetary Policy Committee of the Bank of England but also the incoming Governor Mark Carney will be questioned by the Treasury Select Committee. If I were in his shoes I would consider it wise to talk plenty but say very little! However a bit later in the day we will get the results of the deliberations of the European Central Bank (ECB). Here something has changed and if we look back to this time last year it becomes clear what.

February 2012

I would like to take you back to the press conference of the ECB meeting then where we told this.

Real GDP growth in the fourth quarter of 2011 is likely to have been very weak. According to the survey data for the last two months, there are tentative signs of a stabilisation in economic activity at a low level.

Okay so a bit of a struggle but the Euro area had some growth and was expected to stabilise. The ECB responded to this as shown below.

Since the first three-year longer-term refinancing operation (LTRO) was conducted in December 2011 we have approved specific national eligibility criteria and risk control measures for the temporary acceptance in a number of countries of additional credit claims as collateral in Eurosystem credit operations, which should lead to an increase in available collateral

So we had in response two Long Term Repurchase Operations which totalled just over one trillion Euros and the eligibility criteria were very “liberal”. Also we got this in spite of the inflation position.

Euro area annual HICP inflation was 2.7% in January 2012, according to Eurostat’s flash estimate, unchanged from December

We had also recently seen cuts in the interest rate of the ECB at both its November and December meetings. So we can conclude that it was putting its foot to the floor in monetary policy terms.

The real economy

You might think that it was in quite a state. However we already know that inflation was above target which poses a question about policy easing so let us look deeper. We now know that the Euro area as a whole grew by 1.4% in 2011 according to Eurostat but had dipped by 0.3% in the final quarter. The Euro area unemployment rate was 10.8%.

Now let us step forwards to February 2013

We now know that 2012 was a difficult year for the Euro area with overall growth being expected by Eurostat to be -0.4% which is 1.8% worse than the 2011 performance. We also know that the unemployment rate deteriorated by 0.9% over the year as it is now 11.7%. the latest retail sales numbers for the Euro area told us this.

In December 2012, compared with December 2011, the retail sales index dropped by 3.4% in the euro area

We also had a the latest business survey which unless you work for the business section of BBC News 24 showed another contraction. Apparently a reading of 48.6 below the 50 benchmark is “really strong” to them! Anyway we saw this.

A diverse picture was seen among the four largest euro members, with strong growth in Germany –output grew at the fastest rate for just over a yearand- a-half – contrasting with ongoing downturns in France, Italy and Spain.

So if we exclude Germany the picture looks rather grim and personally I would like to see some other numbers for her backing this up. We have a Euro area of three speeds with more and more moving into reverse gear.

Has monetary policy tightened?

During 2012 we saw one more rate cut in July reducing the official rate to 0.75% and the deposit rate to zero. However as we stand right now there have been some signs of a tightening of conditions.

The Euro exchange rate was falling in early 2012 giving its economies a competitive boost as it dropped on a trade weighted basis from 107.28 in May 2011 to 94.4 in July 2012. However since then it has been rising and as I type this it is at 102.46 so up 8.5% from the lows and higher than at this time last year. so recently we have seen a tightening of conditions here.

We also now know that quite a few banks have been repaying their LTRO funds after only a year of the three-year term. I think that this in itself is ominous as if you cannot make a profit on funds only costing you 0.75% per annum you must have a very grim outlook! Of the first LTRO some 140.5 billion Euros has already been repaid and of the second from the various announcements it looks as though the repayment amount will be in total over 300 billion Euros. We will not know properly until the end of this month but we do know that monetary policy will be tightening here too.

You can also put the decline in stimulus policies this way.

The annual growth rate of the broad monetary aggregate M3 decreased to 3.3% in December 2012, from 3.8% in November 2012.

Also we see that banks are not helping busnesses expand and in fact are a contractionary influence at present.

The annual growth rate of loans to non-financial corporations was more negative at -2.3% in December, from -1.9% in the previous month


I have looked at this topic in this way because if you were a Martian observing events from afar you would be expecting an easing of policy from the ECB today. In real economic terms the situation is worse than it was a year ago when the ECB responded with two interest-rate cuts and a just over a trillion Euro liquidity supply. But of course if we continue with the theme that central banks protect other banks rather than real economies we can recall this from last February’s ECB press conference.

The soundness of bank balance sheets will be a key factor in facilitating an appropriate provision of credit to the economy over time

It always seems to be the banks does it not? And as I pointed out in my latest update on Spain the rise in mortgage rates seems to indicate that rather than passing the help they have received on they have done the reverse. Indeed the bank lending figures above sing from the same hymn sheet.

Also the soundness of bank balance sheets has seen some questions that need to be answered. In Italy the world’s oldest bank Monte del Paschi has been caught red handed using derivatives to misrepresent it figures and required a bailout. Fans of the ECB taking over Euro area bank supervision may like to look away now as the supervisor of this bank was none over than Mario Draghi! Also in the Netherlands the fourth largest bank SNS Reaal has been nationalised at an expected cost of 3.7 billion Euros,although I note that an extra 5 billion Euros have been provided too. Oh and a promise of a profit on the investment for the Dutch taxpayer which is a very oddly declining verb as it moves into the future!

But if we return to 2012 we saw that when the banking system was under pressure the ECB came over the hill like the US Cavalry. So we will see a test later as to what it does when the real economy is under a lot of pressure.





11 thoughts on “Why has the ECB allowed monetary policy to tighten in an economic crisis?”

  1. Justathought says:

    Hi Shaun,

    …and monetary tightening suffocates the peripheral eurozone economies! Tensions are inevitably going to mount inside the Euro Group over the rise in the value of the common currency! Many clues are appearing everywhere that the EU projet might be terminal…

    1. Anonymous says:

      Hi Justathought
      I listened to the ECB press conference and thought it was kind of President Draghi to confirm my themes. His claimed successes were in the financial markets whereas as one of the questioners pointed out the economic recovery he was forcasting was getting further away!
      Oh and he found himself not guility on Banka Monte Paschi too…

      1. Andy Zarse says:

        Hi Shaun, was there any comment on Ireland and her latest proposals for AIB/NAMA?

        1. Anonymous says:

          Hi Andy

          Mario Draghi batted the ball away but did so in a way that suggested some sort of deal had been done. Rather in tune with the times it turned out that the Irish government had followed the model of Ocean Finance as it exchanged lower payments now for a longer period of debt and a higher overall debt value!

          However I note that even now there appears to be some debate over the exact figures and by how much Ireland’s fiscal deficit will be reduced….

          1. Pavlaki says:

            The ECB can call it what it wants but by doing this they are in effect making a fiscal transfer and undertaking direct support of Ireland. They can say it is only a loan but if I borrow money from you and then extend the terms of repayment so far into the future as to be meaningless then you are really just giving me the cash! If I were German, I would be really worried.

          2. Anonymous says:

            Hi Pavlaki

            As much of this is being manouevered around the balance sheet of the Central Bank of Ireland we return to who is the lender of last resort in the Eurosystem?

  2. ernie says:

    Shaun isn’t it the case that protecting the banks is so vital because they have loaded up on peripheral country debt following the 3-card trick played last year via the ECB whereby it leant money to them to buy their countries’ distressed bonds and then allowed them to pledge same bonds as collateral for the loans? Obviously if you allow a few such banks to fall over (say in Spain and Italy to name but two countries) then you have a real problem for the ECB itself. I don’t really see how the ECB is “solvent” given the collateral it currently holds and its own leverage but then I guess that’s the same for all the central banks. I realise their “solvency” isn’t treated the same, but actually the ECB is a different case as it is an uncomfortable sort of hybrid central bank.

    1. forbin says:

      the ECB will always be solvent

      its a political entity – not a real bank

      As Shaun said “It always seems to be the banks does it not? ”

      Western ‘ mocrasy has divolved to governance of the people by the banks

      why else its always the banks that get hughe sums of money ?

      Can you see any other sector getting any benefit at all ??

      on the side lines with popcorn

      this is a party were we are just spectators – you’re not invited I’m afraid ( but you’ll get the bill at the end of the evening!!)


    2. Anonymous says:

      Hi Ernie
      Believe it or believe it not but quite a few supposed experts claimed that banks loading up on the debt of their sovereign nation was a cure for all this. Business Daily on the World Service had a professor from Southampton University who kept plugging this line and they kept inviting him back! I note even they spotted the flaw as it didnt fix anything and he did not seem to be on anymore……
      However I cannot venture that he has not been back recently as a programme I used to enjoy deteriorated so much I very rarely listen now.

  3. Anonymous says:

    Hi Shaun,

    The Netherlands bill of 8.7 billion euro is added to a national debt about 65% of GDP (150 billion). So the new debt will be roughly 71% of GDP – Netherlands isn’t joining the eurozone’s bankrupt club yet.

    However the news of economic woe from Italy, Spain & France matched to the Euro’s recent strength seems to challenge the efficient markets theory.

    1. Anonymous says:

      Hi Expat
      I did not mean to imply that the Nehterlands could not afford to do this as we stand. But we know that bank bailout costs are first estimated as the minimum they might be and they invariably rise. We also know that the economy of the Netherland hit a bit of a brick wall in late 2012. So as my updates on her have suggested the going is getting tougher even in the core.

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