Whatever the failings of the American economy and of US policy elites over the past 5-6 years, we've been consistently more aggressive than our counterparts in the eurozone in fighting unemployment. This weekend, though, we finally got a sign that European Central Bank leaders are open to doing some additional monetary stimulus.
Specifically, speaking to reporters in Washington, DC yesterday the ECB's top dog Mario Draghi said "The strengthening of the exchange rate would require, to make our monetary policy stance to remain equally accommodative, it would require further monetary policy accommodation."
What does that mean?
Draghi is looking at the fact that the price of one euro, relative to one dollar or other major global currencies, has been going up recently. That increase has a number of consequences. One is that it makes it cheaper for Europeans to buy foreign-made stuff or to take foreign trips. Another is that it makes it more expensive for foreigners to buy European-made stuff or to visit Europe. In sunnier economic circumstances, those could be welcome trends (buying cheap foreign-made stuff is fun) but given the very high unemployment rates prevailing in many European countries it mostly serves to make it harder to re-employ all the jobless people.
Another consequence is that it keeps inflation low, since the pricier the euro is the cheaper the euro-denominated prices of stuff are.
That, again, could be welcome in happier economic times. But low inflation that's driven in part by mass joblessness isn't such a happier story. And in the particular context of Europe's debt problems, lower inflation makes it harder for indebted countries to pay what they owe.
What could the ECB do?
Like any central bank looking to stimulate a genuinely depressed economy, the ECB has a number of options:
- Quantitative easing. Since the US has done this a bunch, it has the clearest precedent. Here in addition to keeping short-term interest rates low, you would have the ECB buy up a bunch of longer-term bonds to try to drive those interest rates low too. There may be some legal issues with this in the European context since there are no generic Eurobonds for the ECB to buy.
- Negative deposit rates. Jens Weidmann, Germany's top central banker, has said that a better idea would be negative interest rates on bank reserves. The idea here is that if banks have funds that they're not lending, those funds will be subjected to a small tax. That ought to get more money flowing, especially if paired with a central bank that says it wants to see a higher inflation rate. This is an idea that's been talked about in the United States a bunch but doesn't seem to have obtained serious conversation inside the Fed. Erkki Liikanen, a Finnish member of the ECB governing council, is also a proponent of this.
- Exchange rate targeting. To the extent that Draghi is specifically concerned about the exchange rate, he could simply announce an exchange rate target and say the ECB will keep printing euros and buying dollars until the euro-dollar exchange rate reaches the target. Switzerland did this a few years ago, targeting the exchange rate between the euro and the Swiss franc, and it more or less worked. The general view is that if a large country tried to do this there would be serious diplomatic consequences, but it's not really clear that's true.
- Overshooting. It would be very out of character for the ECB to say this, but any monetary stimulus could be made much more effective by pairing it with a stated desire to "overshoot" the ECB's inflation target. In other words, they could say that they want to compensate for various episodes of sub-target inflation by running an inflation rate that's over 2 percent for a while. That would increase the credibility that any new stimulus measures are going to stick around for a while.