Can Mario Draghi Beat Deflation?
Comment of the Day

February 13 2014

Commentary by David Fuller

Can Mario Draghi Beat Deflation?

Here is the opening from this interesting and informative article by Krishna Guha for Bloomberg:

The European Central Bank may soon have to roll out the heavy artillery, in the form of an asset purchase program similar to those in the U.S., U.K. and Japan, to fight the specter of deflation. But in a currency union with 18 different sovereign bonds, the tough question will be what to buy.

The best solution: Purchase loans from banks -- what I call euro quantitative easing in bank loans.

Despite substantial progress over the past year, the euro-area economy remains vulnerable. Spare capacity and weak growth, along with relative price cuts by countries trying to restore competitiveness, is putting severe downward pressure on inflation. The transition to a European banking union has been prompting banks to cut back on lending for fear of being required to raise more capital, generating a further disinflationary impulse. Deflation, or even sustained very low inflation throughout the euro area, would raise the burden of debt in inflation-adjusted terms, and make it harder for struggling countries to regain competitiveness and bring down their debts.

If the economic outlook and lending trends don't improve, the ECB will have to consider further monetary stimulus at its next policy-making meeting in early March. Its options include reducing its main refinancing rate to 0.10 percent from the current 0.25 percent, and altering the supply of bank reserves with an eye toward imposing a negative interest rate on deposits at the ECB -- a policy that would encourage putting the money to work rather than parking it at the central bank.

The most powerful way to fight deflation risk, though, is by buying assets, also known as quantitative easing. The challenge is figuring out what kind of quantitative easing would be most effective in the euro area.

David Fuller's view

The short answer to the headline question above is, I believe: Yes, provided Mario Draghi is given a free hand to implement policies. 

Meanwhile, the last thing Euroland needs, when trying to recover from a severe credit crisis recession, is further deflation which hampers economic recovery.     

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