At the ECB: Abnormal Monetary Policy is the New Normal

May 16 2018

Boring. Meaningless. Not even slightly entertaining. These are some observations that I have found on Twitter with regard to the most recent ECB board meeting. I saw, however, a press conference that, if I would have to rank all ECB press conferences on a scale of importance, would certainly make it into the top 3 or even to the first place! Especially if you are a precious metals investor. Let me explain why.

It was, in my eyes, not only an important but also a unique press conference by the ECB in April. Not only because it was the last press conference for the vice-chairman of the central bank, Vítor Constâncio (his term comes to an end anytime soon), but also because according to my knowledge it was for the first time in history that a brief remark of the vice-chairman happened to be more important than what the chairman said during the entire press conference. Better yet, what Constâncio claimed last week, was in my opinion more important than 90% of whatever ECB-chair Mario Draghi said in all his press conferences together. What am I talking about? The following.

Because it was Constâncio’s last board meeting, he – among other things – was asked to reflect back upon his term at the ECB. Constâncio did so, and he said something that will be incredibly important for anyone who suffers the consequences of ECB monetary policy. And that includes all of us.

Constâncio’s period at the ECB is largely marked by the fact that the central bank needed a wide range of unconventional means to confront the crisis. Do not only consider quantitative easing (QE), but also unlimited funding for commercial banks and a long-lasting zero interest rate policy.

Unconventional monetary policy was downright necessary in unconventional economic times. Now times have returned to normality, it is time to bring monetary policy back to normality as well. At first glance, the ECB is trying to do so. The central bank has reduced the size of its quantitative easing program from €80 billion euro a month to currently €30 billion and the plan is to put an end to quantitative easing entirely later this year. But wait! Not so fast!

Yes, the ECB has begun with what we could call a normalization of monetary policy, but this does not mean that monetary policy will ever, or at least in the near future (say, the coming five years or even longer), become normal again.

“The set of unconventional instruments that were used are now part of the toolkit of monetary policy to be used if necessary in situations that may justify again that those instruments would be used. Thinking more about the future, as was implicit in your question, I have doubts that on the other hand, one can go back to the simple life of monetary policy as it used to be, with very small central bank balance sheets and just policy targeting the overnight money market rate. Perhaps things will have to change a bit for two main reasons. The first one is that the structure of the financial system has changed enormously. Even in Europe we are now a much less bank-based system than we used to be. If you take total external financing of non-financial firms including then equity instruments, bank loans represent only 15% of total external financing of non-financial firms. So, the structure has evolved dramatically, which means that the system that monetary policy has to think about, to decide on proper transmission of monetary policy, is different. The second element which makes it different is that the complexity of the financial sector and the growing importance of the non-bank part of the financial system mean that the spectrum of interest rates that are more and more relevant is different. Monetary policy trying to influence only the overnight rate perhaps will not be enough. I am not fully sure of that but I think reading, by the way, several academic papers that have been thinking about this, that other instruments may become necessary and a broader targeting of other interest rates to ensure an effective transmission of monetary policy. All central banks are now thinking about this medium-to-long-term future of monetary policy in an ever-more-complex environment of finance.”

These words of Constâncio are for me the reason that the April 26 ECB press conference should be regarded as one of the most important ever.

What Constâncio said is, after all, not just that the ECB could and will resort to unconventional instruments much faster than before, but also that new unconventional instruments must be introduced (“other instruments may become necessary”).

What is important in this regard, is the fact that quantitative easing or zero percent interest rates will not be new or even unfamiliar in the future. Because such monetary policy was until recently unfamiliar and new, the bar to resort to unconventional policy was rather high. That bar was, moreover, high because there was a lot of legal uncertainty. Did the Maastricht Treaty, for instance, allow for large-scale purchases of government and corporate debt? We have now arrived at an answer to that question. The European Court of Justice ruled that quantitative easing, even without limits, was allowed under Maastricht. Familiarity might be the enemy of change. Yet this is no longer a point of debate in the future: unconventional monetary policy is anything but unfamiliar now.

Given his position within the ECB, we can quite frankly assume that Constâncio represents a majority of views on the ECB board. After a few conversations with persons who could confirm that, I know for certain that this is true. The fact that the ECB has mirrored Constâncio’s words on its own Twitter-account, underlines that, especially if we take into account the following: when one of Constâncio’s colleagues, the Austrian central banker Ewald Nowotny, said a few weeks ago that the ECB could raise one of its interest rates in the short run, the central bank released a press note to make clear to the public that Nowotny was not speaking on behalf of the ECB. A similar press note was not released after Constâncio’s statements. Better yet, the ECB shared Constâncio’s words with its followers.

The consequences of Constâncio’s words cannot be underestimated. After all, it means that central banks, especially the ECB, will influence financial markets permanently in a stronger fashion than in the pre-crisis era. In concrete, this could mean that rates of all maturities could increase much more gradually than as before and perhaps that interest rates will not reach levels we have experienced before the crisis. And if rates threaten to escalate by rising too fast or too high, then the ECB will be ready to intervene directly. Put differently: the abnormal monetary policy of structurally low interest rates is the new normal. The consequences are manifold.

Think for instance of savers. Savers can be sure that saving will be a losing proposition for the foreseeable future. In line with that, it would not surprise me if even the most dedicated among savers will put their money (partly) in bonds, stocks and/or precious metals. The last category appears especially attractive since history teaches us that structurally very loose monetary policy will rather push up than push down precious metals prices.

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