ECB Shadow Council sees no reason to set a rate floor of 1%

At the regular meeting of the ECB Shadow Council held on Thursday 30 March, there was a large majority in favour of lowering the ECB's refinancing rate below 1 %..Only two members sided with ECB officials who have recently stressed that 1 % should be the floor of the policy rate in order to preserve the functioning of the money market. Of the 15 members, one argued in favour of a cut by 100 basis points to 0.25 %, five were in favour of a cut by 75 basis points to 0.5 % and seven in favour of a cut by 50 basis points to 0.75 %.The remaining two members advocated a cut of 25 basis points to 1 %.

.Growth prospects and inflation forecasts made by Shadow Council members continued their precipitous decline. The nine members who regularly provide forecasts lowered their GDP forecasts for 2009 on average from minus 3.3 % to minus 3.7 % and the disinflation forecasts (HICP) from 0.4 % to 0.3 %. Under the assumption the assumption that the ECB will lower its policy rate to 1 % in the near term, members projected that real GDP next year would grow only by 0.4 percent, along with inflation at 1.2%, undershooting the desirable inflation rate of around two percent.

20090.3 (0.4)-3.7 (-3.3)
20101.2 (1.2)0.4 (0.5)

Contributors:. M. Annunziata; E. Bartsch; J. Cailloux; J. Callow; S. King; .J. Krämer; T. Mayer; E. Nielsen; J.-M. Six
Assumptions: Forecasters assumed on average that the ECB would cut its key rate to 0.92 percent within the next three months and also within six months.

.The two members advocating only a small cut argued that a rate of 1 % was already very low and lowering it more was likely to be ineffective. The dominant view, however, was that interest rate policy would have an effect until the refinancing rate had reached the zero boundary. Members stressed that the economic situation was very grave, with a very large and growing degree of underutilization in general and unemployment in particular to be expected, such that any additional support that monetary policy could give was urgently needed. Several speakers warned that the risk of deflation had markedly increased. While no member had negative inflation rates in their forecast for next year, the prevailing mood was that it was important to counter this risk, because it was very hard to do anything, once deflation had materialized.

.The argument that a refinancing rate below 1 % would hurt money market funds and that a substantial spread needed to be preserved between the refinancing rate (the ECB?s main policy rate) and the deposit rate, at which banks can park extra liquidity at the ECB) in order to keep the money market working, met with great scepticism in the Shadow Council. While some members agreed that the argument was valid in principle, the overwhelming view was that the importance such technical considerations was dwarfed by the very strong need to make monetary policy as simulative to the economy as possible.

.Members discussed the merits of making a commitment to keep rates low for an extended period of time. About half the members supported such a commitment by the ECB. The other half judged it either redundant or detrimental. Those who said it was redundant argued that the economic situation was so dire, that hardly anyone expected rates to go up any time soon. It was stressed that any commitment could only be conditional. Those members supporting the measure argued that such a commitment would help lower the rates further out in the maturity spectrum.

.In addition to lowering interest rates, there was very broad support for additional unconventional measures to improve the supply of credit to the economy. All members favored a lengthening of the maturities of the ECB?s refinancing operations with banks, a measure that several members of the ECB Governing Council have hinted that the ECB will take. Members expressed the expectation that banks would provide more and cheaper credit, if they had the opportunity to refinance with longer maturities at low rates.

More than two thirds of the members advocated some form of unsterilized quantitative easing, i.e. the central bank buying assets which would result in an increased money supply. Few members, however, advocated buying government bonds. Members warned of the difficulty of deciding which nation?s bonds to buy. Also, several members confessed that they had been sobered by what they considered a unfavorable experience with such a measure in Britain. The option of buying recently securitized loans and other assets from banks drew most support, followed by buying corporate bonds and corporate certificates of deposits (both issued by non-banks and banks) on the market..

Membership Changes

Marie Diron, returning from a short leave of absence, filled the seat that Christian Bordes has vacated for personal reasons..

Individual Votes

Members' individual votes for May 7:
Jose AlzolaThe Observatory Groupcut 0.5
Marco Annunziata


cut 1.0        
Elga Bartsch

Morgan Stanley

cut 0.5
Agnes Benassy-QuereCEPIIcut 0.5
Jacques Cailloux


cut 0.75
Julian CallowBarclays Capitalcut 0.75
Giancarlo CorsettiEurop. Univ. Institutecut 0.5
Marie DironOxford Economicscut 0.5
Stephen King


cut 0.75
Jörg Krämer


cut 0.25
Thomas Mayer

Deutsche Bank

cut 0.5
Erik NielsenGoldman Sachscut 0.75
Jean-Michel SixStandard & Poor'scut 0.25
Angel UbideTudorcut 0.75
Charles WyploszGrad. Institute. Genevacut 0.5

Frankfurt, May 1, 2009
Norbert Häring
Non-voting Chairman

Appendix 1

Quotes from individual members of the Shadow Council
(in no particular order)

"We are in a very, very serious situation with profound deflation risks due to enormous amounts of spare capacity."
Stephen King, Chief Economist of HSBC

"Lowering the refinancing rate below 1% would cause difficulties as the spread between this rate and the deposit rate would shrink too much. This would make it less costly for banks to park liquidity with the ECB."
Jörg Krämer, Chief Economist of Commerzbank

"Cutting the refinancing rate to 0.75 % would push the deposit rate to 0 %, which I don?t see to create particular problems as the EONIA overnight rate seems unlikely to follow suit."
Elga Bartsch, European Chief Economist of Morgan Stanley

"It is true that a rate cut significantly below 1 % might kill off the money market. But this is only a technical issue whose importance dwarfs in comparison to the primary goal of kick-starting the economy."
Josè Alzola, Senior Economist of The Observatory Group

"The growth outlook is still deteriorating, albeit at a slower pace, and we probably facing rapid further tightening of credit conditions."
Marco Annunziata, European Chief Economist of Unicredit in London

."If the ECB were to drive down rates to rock-bottom levels, then, since we are seeing improvement in the money markets, it may not be necessary for the ECB to undertake quantitative easing.""
Julian Callow, Chief European Economist of Barclays Capital

"All major forecasts include a further expansion of the output gap and - at best - a very slow recovery starting late this year, with inflation remaining well below its target for the foreeeable future. Hence, the refinancing rate should be cut to its practical floor which is no higher than 0.5%."
Erik Nielsen, European Chief Economist of Goldman Sachs

Appendix 2

Background information

The ECB Shadow Council was founded in 2002 upon an initiative of Handelsblatt, the German business and financial daily. It is an unofficial panel, independent of the ECB/Eurosystem, and comprising fifteen prominent European economists drawn from academia, financial institutions, consultancies and research institutes.

The Shadow Council usually convenes by telephone conference on a monthly basis (though in November it holds a face-to-face meeting). Discussions take place a week before the monthly official ECB Governing Council "policy" meetings, and are intended to formulate an opinion as to what monetary policy decision its members believe that the ECB's Governing Council ought to undertake, both at its forthcoming meeting and also on a three month horizon. Shadow Council members are encouraged to submit their own economic projections for euro area activity and inflation on a monthly basis, which constitute the panel's forecast consensus as published each month.

The Shadow Council's discussions and recommendations differ from surveys of economists concerning the outlook for ECB interest rates because the Shadow Council recommendation expresses the majority view of its' members opinions about what the ECB should do, rather than what they forecast it to do (hence the "normative" views as expressed by Shadow Council members as to what they consider the ECB ought to do, can differ from what they expect the ECB to do). This "normative" perspective can, however, give an early indication of shifts in the balance of opinion in the expert community, as can be seen by comparing the historic recommendations of the Shadow Council against subsequent decisions undertaken by the ECB Governing Council.

Members of the Shadow Council base their recommendations on the ECB's objectives as defined under the EU Treaty, although Shadow Council members do not necessarily adopt exactly the ECB's specific interpretation of its mandate: most Shadow Council members consider that a medium term inflation objective of two percent with a symmetric tolerance band around it would be clearer, more realistic and more appropriate than the definition adopted by the Governing Council, which defines price stability as an inflation rate of "below, but close to, two percent", in the medium term.

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