It would be premature to say that Europe is out of this mess, but they are certainly heading in the right direction. Italy and Spain had successful debt auctions this week. Spain issued €10 billion, twice what was expected, and Italy issued €8.5 billion. Both countries saw yields decrease significantly which will lower the borrowing costs of these distressed governments. At the moment it appears that the European Central Bank (ECB) has provided adequate liquidity both for European banks, and the sovereign debt market through their fine tuning operations.
Last month, I speculated whether the ECB would avert a crisis through their fine tuning program. This is why I and many other economists and financial analysts have been paying close attention to the Italian debt auctions this week. The early indications look as though the ECB's fine tuning has (at least) been somewhat effective. Italian 1 year securities fell to 2.735%, down 53% from their auction yields last month. This provides much needed breathing space for Europe.
I had called this crisis an "avoidable catastrophe" because there really was not any real reason that Europe had to endure a catastrophic break up of the currency or bankruptcy of some of their major states. The main problem in Europe has been political, and the barriers to solving the problem have been exacerbated by the complexity of Europe's current governing structure. European member states have significant structural issues relating to my of their governments' size relative to their economy's size. Germany, France and others have demanded that governments such as Greece and Italy undergo austerity, a step that is likely necessary in the long run, but crushing these fragile economies now. Europe has also entertained the idea of creating Euro-bonds and other elements of fiscal unity, but steps this important are difficult to do in the middle of a crisis. If the European Union is to be continued, fiscal unity is likely necessary, but those decisions should be made without the threat of a depression hanging over politicians' and voters' heads.
Today, the ECB also decided to keep its main rate at 1%. I would lower them further as much of Europe is now in a recession, but they've been doing this longer than I have. Reserve requirements for European banks will be lowered from 2% to 1% starting on January 18th in accordance with last month's ECB measures to support bank lending and there will be another equally strong dose of fine tuning still to come in March.
This is not over, but these are crucial positive steps from the brink of a serious and long term economic depression. Let's hope that Europe continues along this path!
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| Rome (photo: Russell Yarwood) |
I had called this crisis an "avoidable catastrophe" because there really was not any real reason that Europe had to endure a catastrophic break up of the currency or bankruptcy of some of their major states. The main problem in Europe has been political, and the barriers to solving the problem have been exacerbated by the complexity of Europe's current governing structure. European member states have significant structural issues relating to my of their governments' size relative to their economy's size. Germany, France and others have demanded that governments such as Greece and Italy undergo austerity, a step that is likely necessary in the long run, but crushing these fragile economies now. Europe has also entertained the idea of creating Euro-bonds and other elements of fiscal unity, but steps this important are difficult to do in the middle of a crisis. If the European Union is to be continued, fiscal unity is likely necessary, but those decisions should be made without the threat of a depression hanging over politicians' and voters' heads.
Today, the ECB also decided to keep its main rate at 1%. I would lower them further as much of Europe is now in a recession, but they've been doing this longer than I have. Reserve requirements for European banks will be lowered from 2% to 1% starting on January 18th in accordance with last month's ECB measures to support bank lending and there will be another equally strong dose of fine tuning still to come in March.
This is not over, but these are crucial positive steps from the brink of a serious and long term economic depression. Let's hope that Europe continues along this path!
Great read, but one question:
ReplyDeleteReserve Reqs are that low? 1-2%?
The US Fed dictates a 10% RR for liabilities over $71mil.
Is this an apples-to-apples comparison, and do you see any danger in that low of a RR?
Or am I missing something?
-Steve
I noticed that as being really, really low too. This might be part of the "ECB performing monetary policy" differently. Or as Bernanke might say that their "channel of monetary transmission" is different than the US, so they have to operate differently. China also uses reserve ratios more than interest rates to influence the money supply.
DeleteThey have rules about not buying debt from member nations, and even while the US doesn't directly buy US debt, we do it indirectly through primary dealers. I don't think that the ECB is even allowed to do that in an indirect manner like the Fed.
So, if this is simply how they primarily do monetary policy, then the low, low RR might not be a problem, because they'll still be a lender of last resort and they can hold up banks that find themselves too close to 0. But obviously it's closer and I think that's why most central banks set reserve ratios higher, and prefer to use interest rates more prominently.