Tuesday, September 15, 2009

The ECB's Balance Sheet At A Glance

by Claus Vistesen

What follows is essentially the fruit of the last week's labour. It is a detailed look at the ECB's balance and the related question of whether we can call, what it is that ECB the is doing quantiative easing or not?

Needless to say, I think that this question is an important one in a general context since if my intuition that the epicentre of the global financial and economic crisis has now migrated from the shores of the United States to the periphery of Europe is right, then a detailed look at the ECB's policies and arsenal is not only merited, it is essential reading.

With the distinct risk of turning this into a cheesy copy of the Oscars show I should thank Edward Hugh for his patient and thorough back-editing of my English language blunders and for his seemingly unlimited availability when I needed someone to sound out about the arguments themselves. All mistakes and mishaps naturally fall on my shoulders and criticism should be directed accordingly. Here I simply reproduce the executive summary but you can download the full report - which is currently in the form of a working paper online here. The analysis includes data up to week 35 (and up to July in the case of monthly data). If you want a copy of the spread sheet, I will willingly provide if you simply let me know.

Executive Summary

Is the ECB deploying a variant of Quantitative Easing in any fashion, way, shape or form?

If you are talking about Quantitative Easing senso strictu then my answer has to be a simple and straightforward no. However, if we stop being quite so by the letter of the book, and broaden our definition slightly, then I would strongly suggest that the battery of credit enhancing measures put in place by the ECB when taken together with the steady increase in securities accepted onto the balance sheet as collateral, do make it evident that the ECB - whether wittingly or unwittingly - has moved into some form of what we could at least call "quasi" Quantitative Easing.

Is the ECB indirectly monetizing the debt issuance of Eurozone governments?

If my initial answer to this question - before actually going through the books - would have been an outright yes, I now feel the need to tread much more carefully on this point, since I have most definitely not been able to conjure up that proverbial smoking gun. In fact, it has proved very difficult to establish any kind of direct link between the amount of funding drawn from the ECB refinancing operations and the purchase of government bonds by the MFIs at the national level.

This is not to say, however, that circumstantial evidence is not available that this process is taking place to some extent, and in some countries. I do believe, for example, that the massive purchase by Spanish MFIs of government bonds in that country does offer prima facie evidence that some such connection may well exist, and thus all I can say at this point is that further research is called for, and especially a much more detailed and discriminating data-mining dig-down.

What are the prospects and possibilities for a viable exit strategy for the ECB from its non-standard monetary policy measures?

The measures collectively known as Enhanced Credit Support are by their very nature flexible. However, if there is anything we have learnt from the operation of monetary policy in Japan over the last twenty years it is that premature exit from the sort of substantial support the ECB is offering only makes matters worse, and in addition this kind of massive liquidity easing is a lot easier to get into than it is to get out of.

A true economic recovery will inevitably be somewhat selective, and it is at this point that the ECB's problems will really start, since the recovery will begin in some countries and not in others. To take the extreme case: it will be awfully hard to maintain massive monetary easing for a Spanish economy which remains stuck in an "L" shaped non-recovery if in France headline GDP growth were to start to tick back again towards - say - 2%. Then the real dilemmas which face the ECB will begin in earnest. As such, it is going to be much more difficult for the ECB to instigate that dearly beloved exit strategy than many currently like to believe.

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