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ECB: I cannot do whatever it takes

The ECB just announced a further reduction in interest rates, extended its QE program by increasing the rate at which buys assets, beefed up the TLTRO program and extended its horizon. It all sounds like good news and many of these actions had been expected in the last meeting of 2015 and they did not happen. Markets reacted very positively on announcement but later, after the press conference, they went down to levels that were significantly below where they were before the announcement.

It is always hard to comment on why markets react in a certain way to monetary policy announcements but I must say that watching the press conference I learned about the state of desperation and possibly confusion of the ECB, which was not very reassuring. It might not be their fault, this is life when central banks hit the zero lower bound on interest rates and there is very little they can do. And the available tools are not easy to communicate to markets and the general public. An extra 20 billion for QE, including corporate bonds, loans to banks that have an interest rate contingent on the amount of net lending are all policies that are much harder to understand and calibrate (even for economists) than a reduction in interest rates.

So what did we learn yesterday? That the ECB wants to do more but that there is no magical tool that will get the Euro area out of where it is. That the ECB is willing to do more, despite some of the internal resistance, is good news. But the message (explicit and implicit) that they have clearly reached their limit is bad news. From the press conference it was clear that interest rates cannot go down any further. And when it comes to QE there is always room for enlarging the set of assets that are included in the program but the Bank of Japan has tried that for a while without great success.

In summary, the zero lower bound trap is a real one. In the absence of aggressive fiscal policy or a sudden and large improvement in the world economy, the ECB is going to have a hard time reaching its inflation target or helping the Euro zone economy return to normal growth rates.

Whatever it takes to fix this does not seem part of the tools that the ECB has at its disposal. And I do not want to think about what future ECB press conferences are going to look like.

Antonio Fatás

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