CAMBRIDGE – The European Central Bank needs to ease monetary policy further. Eurozone-wide inflation, at 0.8%, is below the target of “close to 2%,” and unemployment in most countries remains high. Under current conditions, it is hard for the periphery countries to reduce their costs to internationally competitive levels, as they need to do. If inflation in the eurozone as a whole is below 1%, the periphery countries are condemned to suffer painful deflation.
The question is how the ECB can ease policy, given that short-term interest rates are already close to zero. Most of the talk in Europe concerns proposals to undertake quantitative easing (QE), following the path taken by the US Federal Reserve and the Bank of Japan. This would mean expanding the money supply by buying member countries’ government bonds – a realization of ECB President Mario Draghi’s “outright monetary transactions” scheme, announced in August 2012 in the midst of growing uncertainty about the euro’s future (but never used since then).
But QE would present a problem for the ECB that the Fed and other central banks do not face. The eurozone has no centrally issued and traded Eurobond that the central bank could buy. (And the time to create such a bond has not yet come.) By purchasing bonds of member countries, the ECB would be taking implicit positions on their individual creditworthiness.
That idea is not popular with the eurozone’s creditor countries. In Germany, ECB purchases of bonds issued by Greece and other periphery countries are widely thought to constitute monetary financing of profligate governments, in violation of the treaty under which the ECB was established. The German Constitutional Court believes that the OMT scheme exceeds the ECB’s mandate, though it has temporarily tossed that political hot potato to the European Court of Justice.