The Challenges of the New European Central Bank President

The most important challenge facing Christine Lagarde will be Germany’s reconciliation with the European Central Bank (ECB)[1], in particular if the ECB President’s major belief is that the euro zone needs to create more of its economic growth at home, including via greater public investment, if it is to withstand weakness abroad and become more balanced internally.

A Blog Article by Dimitrios Koumparoulis.

The new head of the European Central Bank (ECB) is characterized by ability to reach compromises, with which everyone can move forward. It is noted, however, that her critics are mainly in Germany, where savers, bankers and academics are complaining about negative interest rates and the bond buying program.

In early September this year, the ECB cut interest rates on negative territory to -0.5%, a measure aimed at encouraging them to lend, thus, boosting demand and inflation. But it is not unlikely that the opposite will happen, say financial analysts, as this negative interest rate damages the profitability of banks, which may decide to keep cash in their vaults and reduce lend – a reason why Christine Lagarde should be very careful against them.

Low and negative lending rates have raised concerns in various European capitals with former central bankers and former members of the ECB’s executive board, such as Germans Jürgen Stark and Otmar Issing, arguing among others in their recent monetary policy memo[2] that very low interest rates favor people with real assets, such as real estate, and harm those who, for example, want to save for their old age.

Quantitative Easing (QE)

Another point of controversy is the program of quantitative easing through which the ECB buys government and corporate bonds to boost inflation and reduce borrowing costs. With the latest quantitative easing program, the ECB bought 2.5 trillion-euro worth of bonds in the period 2014-2018. When the program ended, the ECB said it would raise interest rates in 2019 and gradually reverse the loose monetary policy. But much has changed since then. The recent slowdown in economic activity and the risks of Brexit and the Sino-American trade war have prompted the ECB to launch a new program of quantitative easing. The ECB will start buying $ 20 billion worth of bonds per month and most importantly, this program will last for some time.

And this is why Lagarde is expected, as economists in the international media point out, to properly weigh the quantity and timing of the bond market. If movements are timid there is a risk of inflation remaining persistently below the targets of the ECB while if they are very bold there is the risk of destabilizing the financial system.

Danger of New “Bubbles” on the Other Side of the Atlantic – Policy Rethink for a Changing World [3]

“The Fed and the ECB should explain to the public that the monetary policy is only one of the instruments of economic management — fiscal and structural policies are also necessary to produce a steady and sustainable growth. The idea that cheap money alone is the answer to all economic problems leads to policy errors that exacerbate business cycle fluctuations and compromise central banks’ credibility”, as stated by Dr. Michael Ivanovitch[4], who served as a senior economist at the OECD in Paris. Lastly, in an August 2019 survey[5] of 226 economists conducted by the National Association for Business Economics, 38 percent of respondents said they believe the U.S. will enter its next recession in 2020, and 34 percent picked 2021; only 14 percent say it will occur after that.

Written by Dimitrios Koumparoulis

Edited by Pablo Markin

Featured Image Credits: ECB Conference on Monetary Policy: Bridging science and practice, October 7, 2019 | © Courtesy of European Central Bank/Flickr.

References

[1] Kluth, A. (2019, October 8).Christine Lagarde has a German problem. Retrieved from https://www.bloomberg.com/opinion/articles/2019-10-08/christine-lagarde-has-a-german-problem

[2] Memorandum on ECB Monetary Policy by Issing, StarK, Schlesinger (2019, October 4). Retrieved from https://www.bloomberg.com/news/articles/2019-10-04/memorandum-on-ecb-monetary-policy-by-issing-stark-schlesinger

[3] OECD Economic Outlook, November 2019.

[4] Ivanovitch, M. (2019, September 30). The Fed and the ECB must avoid becoming fixers of last resort. Retrieved from https://www.cnbc.com/2019/09/30/commentary-the-fed-and-ecb-must-avoid-becoming-fixers-of-last-resort.html

[5] US economists expect recession in 2020 or 2021: survey (2019, August 19). Retrieved from https://www.businesstoday.in/current/world/us-economists-expect-recession-2020-or-2021-survey/story/373509.html