I know the title will put most people off, but I couldn’t help it. Let me set records straight -
- QE is Quantitative easing the till now most popular unconventional mon pol tool. It simply means buying Govt Bonds thereby expanding money supply. Mostly associated with Bank of Japan move to
- Bernanke added CE or Credit Easing to unconventional mon pol toolbox. It means buying financial assets from credit markets to ease pressures in the same. The assets here could be corp bonds, mortgage backed securities, asset backed securities.
Now ECB Chief Trichet has added ECS or Enhanced Credit Support to the toolbox (or mon pol jargon). In his recent speech Trichet talks about ECS along with many other things -
- History of ECB along with talk on Bundesbank and Banque de France. This is really good . I don’t know but I am seeing many revisits to history these days after complete ignorance earlier. I don’t know whether it is happening intentionally as economists/ policymakers realise their mistakes of ignoring history. But it is highly welcome.
- The crisis (of course): Three multipliers led to the crisis- ill designed incentives, complex fin instruments, macro imbalances
- Diff between US and EU- Euroarea bank dominated, hence focus on liquidity. Euroarea also has more SMEs, housing market not as big a problem in EU and US economy is more flexible than EU.
- Hence the difference in ECB response.
In ECB’s response he explains ECS:
The ECB is engaged in policies that I have characterised as “enhanced credit support”. Let me explain this to you now. This approach focuses primarily on banks as they are the main source of credit in the euro area economy and seeks to provide enhanced support for credit provision through specific policies. Hence, one can make the following definition: enhanced credit support constitutes the special and primarily bank-based measures that are being taken to enhance the flow of credit above and beyond what could be achieved through policy interest rate reductions alone.
The ECS in turn are of two types:
- Liquidity Management. It has 4blocks:
- Provide liquidity
- Expland collateral base
- Extend maturities
- Provide liquidity in foreign currencies
- Buy covered bonds as announced recently- He explains that covered bonds are imp source of finance for EU Banks, hence the selection. He also explains they are not risky like the MBS, ABS etc and thus pose less risk.
He then responds to oft criticism that ECB did not do enough or as actively as Fed:
This brings me to the last point in my speech. The ECB’s enhanced credit support measures are designed in full respect of the euro area macroeconomic framework. Financial support measures potentially involving the significant transfer of credit risk from financial institutions to the taxpayer clearly fall within the realm of fiscal policy. Our decision to conduct outright purchases of covered bonds is fully consistent with this fundamental principle. While they are expected to be effective in supporting credit, these purchases do not burden the Eurosystem with excessive credit risk.
More generally, I have already mentioned that different environments call for different actions, even if there is agreement among central banks about the ultimate objectives. This helps to explain why the ECB’s enhanced credit support measures, by contrast with the concepts of “credit easing” and “quantitative easing”, do not involve outright purchases of sovereign debt. On this feature, I would like to make three comments, stressing pragmatism, principles and preparations for exit.
First, there is a pragmatic explanation. History matters to a prominent degree. In the United States, for example, in normal times outright purchases and sales of treasury bonds with short maturities belong to the routine toolkit of monetary policy implementation. Given that tradition, it may be a natural step, under non-standard circumstances, to adapt this procedure by significantly expanding the volume of purchases and focusing on governments bonds with longer maturities.
The Eurosystem comes from a different tradition. For us, “reverse transactions” with banks – on the basis of repurchase agreements or collateralised loans – are the single most important – and in many respects exclusive – instrument in open market operations. Given that tradition, it has been a natural step to extend the maturity of our refinancing operations and make adjustments to the collateral requirements.
Second, principles need to be stressed very firmly. For reasons known to all of us, the euro area has a clear separation of responsibilities. The ECB’s enhanced credit support fully respects this separation.
Third, preparations for exit are important. The Governing Council will ensure that the measures taken are quickly unwound, and the liquidity provided is absorbed, once the macroeconomic environment improves. Long-term refinancing operations (like operations with shorter maturity) provide liquidity over a fixed time horizon and run off in a fully predictable way. By contrast, the unwinding of outright purchases typically requires an additional decision, namely whether to hold the securities to maturity – and if not, when to sell. The route taken by the Eurosystem limits such decisions to our covered bonds purchases and for the rest relies on built-in mechanisms for the re-absorption of liquidity.
He adds that having an exit strategy does not mean we are going to exit anytime soon. But having them in place is important.
Excellent speech from Trichet. A kind of speech which leaves you gasping with the amount of know-how and insights on so many issues.
Great stuff.
