Today, the European Central Bank (ECB) adopted a comprehensive package of measures geared at bringing the inflation outlook back in line with its 2% target. The ECB cut the deposit rate, introduced a two-tier system for banks’ reserve remuneration, restarted the asset purchase program without an explicit end date, eased refinancing conditions for banks and, last but certainly not least, modified its interest rate forward guidance to make them state-dependent on the inflation outcome and outlook. To paraphrase ECB President Mario Draghi: “Today we used all instruments.” Bond markets responded with sharply lower yields and flatter curves in higher-yielding peripheral eurozone markets and corporate bonds.
With today’s package, Draghi has made the life of his successor Christine Lagarde both easier and more complicated. Lagarde’s life became a bit easier as the adoption of a large range of easing measures today enables the future ECB President to settle into the new job without having to take major decisions right away—clearly a benefit as she has plenty of policymaking experience but lacks a central banking background. At the same time, her life became a bit more complicated for at least two reasons. First—to stay in the parlance of her previous employer, the International Monetary Fund—she needs to display ownership of the measures taken today. While we don’t think there is a big difference in views between Lagarde and Draghi, taking ownership would have been more straightforward if the measures had been instituted under her guidance, especially given the pending policy review. Second, eurozone monetary policy just became a bit more complicated, both in terms of instruments but also, at least potentially, in terms of acceptance across the eurozone population.
It is the last point, public acceptance of the future interest rate path and the ECB as a whole, which might come to haunt Lagarde in a major way, and sooner rather than later. Savers in Germany but also elsewhere in the eurozone will certainly voice dissatisfaction more prominently than in the past if mainstream financial institutions were to cross the Rubicon into charging negative deposit rates for retail clients. This is not guaranteed as the wholesale deposit tiering system introduced today should mitigate commercial bank losses if the ECB were to cut the policy rate even further, which is likely. That said, if commercial banks cannot make up the losses any longer by charging a fee here and there, some might start thinking in earnest about charging their clients for depositing money in the bank. Those clients are not very receptive to the technical arguments that an un-anchoring of long-run inflation expectations constitutes a threat to the monetary transmission mechanism and that that easy monetary policy has helped the eurozone recovery and consumption everywhere, including by reducing unemployment.
This opens the door for pragmatic fiscal policymaking to support monetary policy where there is fiscal space, rather than monetary policy supporting tight fiscal policy—which is what we have witnessed over the last few years. Draghi was particularly forceful today in his plea for fiscal support. By referencing the package’s potential negative side effects, he implicitly conveyed that the ECB will be passive from here on out and put the ball squarely in the fiscal policymakers’ court. He even went as far as explicitly mentioning a sizeable fiscal stimulus package in the Netherlands as a good example. Another example he did not mention is Germany: the government could subsidize retail bonds to produce an above-market yield for retail investors to make up for potential losses on their current accounts due to negative deposit rates. This is the essence of a recent proposal for a Climate Protection Foundation by the German Minister of Economic Affairs and Energy, Peter Altmaier. Clearly a market distortion, but this proposal would kill three birds with one stone—support the ECB in its cyclical stance while running down fiscal reserves built up from surpluses accumulated over the last few years and keeping savers happy. What’s not to like?