ECB Shadow Council discusses the need to provide further stimulus

In preparation of the monthly meeting members debate the pros and cons of resuming the easing cycle. Latest comment by: Marco Annunziata

Gustav Horn

The Euro area is heading for a Japanese scenario: Low growth and slightly deflationary price movements. This scenario can only be avoided if monetary policy acts swiftly and determined by cutting rates to close to zero. The impact of monetary policy on the real economy will anyway be delayed compared to "normal" times since the transmission process via banks is still not working properly. Only after banks get their balance sheet in order again, monetary policy will lead to a sustained economic recovery and a positive inflation rate. That will be the time when monetary policy should reverse its course and start quantitative tightening by selling the respective assets and increase interest rates symbolically to 0.5 % with more to come. This sequence of action should be communicated in advance after the next meeting to clarify ECBs strategy to market participants.
Gustav Horn is Scientific Director of IMK Macroeconomic Policy Institute in Duesseldorf

Thomas Mayer

Economic indicators typically flicker at conjunctural turning points, but my reading of them is that recovery will begin as of the third quarter of this year. Economic history (US in the 1930s, Sweden in the 1990s) suggests that the initial rebound from a downturn associated with a financial crisis can be fairly powerful when the financial sector has been successfully stabilised, although it may not be sustainable. Against this background, I see presently no need to ease monetary policy further. I could see an eventual extention of the covered bond purchase programme to asset backed securities, but this step (and possible further rate cuts) should in my view be kept in reserve in case the rebound indeed turns out to be short-lived.
Thomas Mayer is European Chief Economist of Deutsche Bank in London

Marie Diron

It is clear that the euro area economy is still very weak. The signs of stabilisation are just that: only signs, no firm confirmation and signs of stabilisation, not signs of outright increases in output. Moreover, these signs are far from clear cut yet. In fact, the hard data such as industrial production and trade have disappointed. The improvement seems confined to surveys so far. But what these surveys are telling us is not that a majority of businesses are expecting conditions to improve. They are saying that the share of companies expecting conditions to worsen is no longer increasing. Hardly green shoot material. However, very large stimulus packages both on the fiscal and monetary sides have yet to feed through to the economy. As the economy and financial system is stabilising and returning to more normal functioning, these packages should e more effective. It seems therefore sensible to wait and see for a few months if more stimulus is needed or not.
Marie Diron is Senior Economist of Oxford Economics in London

Elga Bartsch

Since the last Shadow Council meeting, we have seen further signs of stabilisation in economic sentiment and tentatively also of activity over the summer and a modest recovery thereafter. While HIPC inflation is likely to dip into negative territory this month, I am not overly concerned about deflation posing a danger to the euro area. In fact, headline inflation should be bouncing back quite sharply in the later part of this year. True, core inflation will likely ease for some time to come, but I am concerned that potential output growth – the speed limit for inflation free growth – has likely fallen; the unemployment rate consistent with non-accelerating inflation (NAIRU) likely increased. This is why I would to see the past interest rate cuts implemented by the ECB taking full effect and the alternative policy measures decided upon already fully rolled out. The alternative policy measures include both the first ultra-long refi operation with a maturity of one year to be conducted this week and the purchases of covered bonds starting next month. At this stage, I am inclined to leave interest rates unchanged for an extended period of time. Only in the event of an unexpected deterioration in the economic outlook and/or a renewed rise in money market tensions, I would consider a further interest rate reduction to be appropriate.
Elga Bartsch is Chief European Economist of Morgan Stanley in London

Charles Wyplosz

I am skeptical about the good news, although I am very pleased to see that the pessimism that was so pervasive is now disappearing as the pessimism itself powerfully contributes to the recession. I see no reason to rush to remove the easing. First because we need to see some hard evidence that the recession is ending, nit just green shoots and forecasts. Second because the end of the recession does not mean that the output gap is closing; if growth is simply zero - a wonderful news - the gap will still grow, further exercising downward pressure on inflation.
Charles Wyplosz is Professor at the Graduate Institute for International Studies in Geneva

Jörg Krämer

Nearly all survey-based leading indicators point up on trend, I would not recommend to cut rates further. Monetary policy is anyway much more expansionary than suggested by the 1.0% refi as the ECB lends unlimited amounts of central bank money to banks in exchange of collateral.
Jörg Krämer is chief Economist of Commerzbank in Frankfurt

Angel Ubide

I am worried that we may be replaying the Japanese path all over again by talking about exit strategies too soon. The tail risk has diminished, but it has diminished conditional on keeping the stimulative policies in place. Talking about exit is akin to tightening policy, and this is happening too early in the process. Policy makers have an incentive to exit "abnormal" situations as soon as possible, but that should not preclude implementing an optimal policy. This also implies that policy makers are revealing that policies around the zero bound have extra costs - and thus that the concept of a natural transition from rates into quantities is not correct. If policies are costly around the zero bound, the maybe the inflation objective is to ambitious and should be raised. Two deflation scares in a decade are too many.
Angel Ubide is Chief Economist of Tudor Investment Corporation in Washington DC

Marco Annunziata

While the recent signs of stabilization in economic activity are encouraging, they need to be taken with a substantial pinch of salt. What we are seeing so far is still mostly driven by the inventory cycle, after destocking subtracted 1pp from quarterly Q1-09 growth. Prospects for a recovery in consumer spending in the Eurozone remain very uncertain given rising unemployment and the expectation of higher taxes down the line, and the financial sector remains fragile. The ECB’s own estimate of future banking system losses imply a meaningful risk of further credit supply contraction. There are also still significant downside risks to growth in the rest of the world, especially the US. Moreover, I think the ECB will need to watch carefully the behavior of inflation expectations over the coming months as headline inflation will settle temporarily below zero. On balance, I still believe the underlying weakness of the economy warrants rates close to zero. I do acknowledge, however, that the signs of stabilization make further policy easing at this stage less urgent. The priority now should be to give a very clear signal that the bank remains ready to take additional policy action should the recent signs of stabilization fail to consolidate. Commitment to a timely exit is important to maintain credibility, but it is equally important to avoid a premature tightening of policy. In this regard, I would caution against over-estimating inflation risks at this juncture. We forecast core inflation to trend steadily towards zero by end-2010, driven by the widening output gap. Barring an unexpected and implausible sharp rebound in growth, it seems extremely unlikely that inflation will become a threat over the next 18 months—as confirmed by the ECB staff’s projections. It is important that policy be driven by forecasts rather than by fears.
Marco Annunziata is Chief Economist of Unicredit in London

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