In announcing a new round of extraordinary measures to support the euro-area recovery, the European Central Bank is sending three loud and unambiguous messages. Their implications extend well beyond Europe.
First, it is committed to experimenting even more with its use of unconventional monetary policy, including by taking the deposit rate even more negative and starting a program to purchase asset-backed securities.
Second, it is positioning itself for full-scale quantitative easing -- but on the condition that European governments show more flexibility on fiscal policy and put into place the structural reforms needed to support healthy growth.
Third, it isn't too worried about a multitrack world of central banking, in which its policy loosening contrasts with moves by the U.S. Federal Reserve, the other systemically important central bank, to remove monetary stimulus.
Related: The Euro Is Draghi's Only Friend
The ECB's moves come in the context of legitimate concerns about the momentum of Europe’s already-sluggish economic recovery. They are part of a broader policy framework with four main elements:
- Force down bond yields and interest rates, hoping that this supports jobs and growth by restoring proper credit flow throughout the monetary union.
- If this doesn't work fast enough, repeat with more aggressive use of bond purchases, hoping also to promote export growth by weakening the currency.
- Pressure governments, both privately and publicly, to implement much-needed measures to promote growth and avert deflation.
- In all this, hope that the costs and risks of experimental monetary policies don't overwhelm their benefits.
The success of the ECB's strategy, and its impact on the rest of the world, depend heavily on the extent to which European governments do their part. And the longer these governments dither, the greater the risks.
In the short term, the ECB's extraordinary measures are likely to affect other countries mainly through financial channels rather than providing what the world really needs -- more robust and durable European economic growth. This will create challenges, putting conflicting pressure on interest rates, artificially boosting equity prices, causing currencies to appreciate relative to the euro, and contributing to global foreign exchange market volatility. From Switzerland and the U.S. to China and other Asian economies, such spillover effects will complicate efforts to stimulate genuine growth and also heighten the risk of financial-market instability down the road.
ECB President Mario Draghi's ultimate objective is to get European governments to do what their economies desperately need to promote durable growth and job creation. He knows that the ECB’s proper role is to support rather than lead the policy parade. To succeed, he needs governments to temporarily ease fiscal consolidation and do more to improve the functioning of labor markets, foster competition, overhaul tax systems, improve infrastructure and generally enhance the business environment.
The immediate impact of the ECB's latest actions will be felt around the world, but not yet in a fashion that is both desirable and sustainable. The ECB and the global economy desperately need European governments to respond constructively.
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Mohamed Aly El-Erian at firstname.lastname@example.org
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Mark Whitehouse at email@example.com