It’s normal to assume there will be a change in policy when an institution has a change of leadership. In fact, it’s kind of unavoidable. Even for an institution like the ECB which has a mandate of maintaining stability, there are different views on how to maintain it.
The restructuring of the governing body of the ECB was a long negotiating process. This was in order to balance two different policy currents: “northern” Europe, lead by Germany, more inclined towards stability; and “southern” Europe, alternately championed by France or Italy, with more focus on helping the economy.
A New Direction?
The latest moves have inclined some analysts to argue that the “center of gravity” of the bank has moved “north”. That is, the Presidency and Chief Economist went from being in the hands of Italy and Portugal to being France and Ireland, respectively. It brings back memories, to some, of the Trichet period.
Christine Lagarde as the new ECB President has been notoriously quiet about her new style. This was at least until the jockeying for the last two members of the Executive Board have been put in place at the beginning of the year. Although Lagarde has a long track record, things often look different from the inside. Such is the case with raising interest rates.
The Bank of Japan Stigma
Since the last financial crisis, more and more central banks have opted for negative rates. As time goes on, a concerning pattern has evolved where none of these banks so far have managed to return to positive rates. The longest in this position of “ultralow rates” is the BOJ. The bank has presided over decades of low growth, ballooning fiscal debt and inflation stagnation. The “leader” in negative rates is hardly setting an appealing example (Denmark was the first to introduce the rates, though largely as a way of maintaining the yield spread with Europe).
Half-way through the last year, there was some speculation that the ECB would move towards positive rates. However, that was dashed in September when the bank went more negative in the face of poor economic data. While there is a growing consensus among the financial community – including members of the ECB itself, such Mersch and Lane – against prolonged low rates Lagarde’s former employer, the IMF, recently came out advocating “deep” negative rates.
There has been quite a bit of speculation with Lagarde’s launch of a “strategic review” of the ECB. Many see its eventual conclusions being used as the base for future policy. Though some also argue that the review isn’t so much a search for the answer, a search for a justification of the inevitable: once going negative, it’s virtually impossible for central banks to return to positive rates. Should the ECB do so before 2022, it likely would be the first in the world; and would be contrary to the expectations of the vast majority of analysts who see negative rates well past 2021.
Even if the ECB manages to pull out of strictly negative rates, it would still be in the position of ultra-low rates that have been the norm for Japan since the mid-’90s. Many point to the economic issues in Europe being remarkably similar to Japan’s over the last couple of decades: broadening deficits, anemic economic growth and currency weakness in a desperate attempt to prop up exporters. The only major difference is that Europe has significantly higher unemployment.
The solution seems to be out of the central bank’s hands: one side argues Germany should join the deficit spending club (in other words, follow Japan), while the other argues for structural reforms (or take the US route). We’ll see which, if any, wins out in the end.