Thursday, August 28, 2014

28/8/2014: Draghi at Jackson Hole: Not 'too little' but may be 'too late'...

Earlier this week I gave a comment for the Portugal's Expresss magazine article on ECB policy:

Here is the full comment I provided:

Q: Can we talk of a “change” in the mood regarding austerity policies after the Draghi’s Jackson Hole speech – too little is worse than too much?

A: Mario Draghi's speech at Jackson Hole was significant for a number of reasons.

Firstly, it is an important signal of the ongoing gradual re-orientation of the ECB attention away from technical inflation targeting toward more detailed consideration of the inflation-leading fundamentals. Technical targeting is still there, but the focus is moving toward the real economy. This is a signal that reinforces, tacitly, previous policy bases, especially the concept behind the TLTROs as opposed to traditional LTROs, as well as the structured asset purchases programme currently in design.

Secondly, the speech clearly signalled the ECB's return to direct opposition to the EU-led structural reforms policies. Specifically, Darghi's focus on unemployment signals growing frustration within the ECB that structural reforms are not working due to their poor implementation, unambitious design and for cyclical reasons. While the media opted to focus on the latter point, dealing with the issues of cyclical timing, and thus with 'austerity' policies, in my view, longer term perspective inherent in Mr Draghi's emphasis on unemployment warrants the view that the ECB is once again moving to pressure Euro area leaders to stay the course of reforms over the long run, even if temporarily opening the door to easing the pressures of reforms in the immediate future.

The above two points are very clear from Mr. Draghi's discussion of structural vs cyclical economic impacts of the Great Recession.

Thirdly, it is also clear that Mr. Draghi is positioning ECB closer and closer to deploying an outright large scale quantitative easing (QE). However, he is painfully aware of the fact that traditional QE will risk pushing Euro area sovereigns further away from the necessity to enact painful reforms and that political cycle is starting to reinforce misdirected economic incentives. Furthermore, he is aware that current yields on Government bonds are not only benign, but outright exuberantly optimistic. Thus, the issue, in Mr. Draghi's view, is not how much QE is needed, but rather of what type - a choice being between the traditional QE (sovereign channel), LTROs-based QE (banking channel), asset buying and TLTRO (private supply side channel) or deleveraging supports (private demand side channel).

The problem with ECB's current stance is exactly that its policy innovations so far ignored the last channel which represents most direct route to stimulating demand and investment, and are yet to specify the penultimate channel which represents direct route to a supply side stimulus.

On the balance, Mr. Draghi's speech was far from being 'too little', although it still might be 'too late'. He touched the most important issue bridging supply and demand sides of the economy - employment - but as he notes, structural dimension of unemployment in Europe makes it very hard for the ECB to enact a traditional set of policy tools suitable more for reducing cyclical unemployment.

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