A Plan for Europe’s Great Unwinding Mario Draghi has less than two years to devise an exit strategy from today’s extraordinary monetary policy. By Richard Barwell and Arnaud-Guilhem Lamy
https://www.wsj.com/articles/a-plan-for-europes-great-unwinding-1523486915
The economic crisis in Europe is finally fading, and Mario Draghi and his colleagues at the European Central Bank can breathe a sigh of relief. Their strategy of negative interest rates and asset purchases is paying dividends. But now the recovery brings fresh headaches for Mr. Draghi. It will soon be time to start the complex task of unwinding the extraordinary and unconventional monetary stimulus that has resuscitated the economy.
The immediate problem facing Mr. Draghi is how to phase out the ECB’s asset-purchase program, known as quantitative easing or QE, and then gradually return interest rates to more normal levels. And that is only the beginning.
The ECB’s balance sheet has doubled in size over the past three years. This is partly as a result of QE. But it is also reflects the €750 billion of cheap fixed-rate, long-term funding that the ECB has lent to banks. In some respects those loans, known as TLTROs, are an indirect form of QE, with the ECB lending the banks cash and the banks buying bonds. Either way the ECB is printing money and its balance sheet is increasing. That balance sheet will eventually have to shrink back to more normal levels.
That will take years. Adding to the complexity, Mr. Draghi’s term as president ends in October 2019. He needs to devise an exit strategy from current ECB policies knowing that he won’t be in charge for much of this process. Although he’ll be keen to signal to investors what to expect from the ECB in the years ahead, there’s no point promising a gradual monetary exit if investors believe his successor will pick up the pace.
Fortunately, there is an option that could simultaneously send a credible signal that interest rates will rise gradually without jeopardizing price stability, wean banks off fixed-rate funding, and acclimate markets to the reality that QE will eventually be reversed. That solution builds on innovations Mr. Draghi has made in the central-bank toolkit. Like all the best central-bank policies, it has an acronym: FG-LTRO, forward-guidance long-term refinancing operations.
The ECB should offer a new round of long-term loans, which would expire in mid-2023, far beyond the expiry of the existing fixed-rate TLTROs in 2021. Banks would be allowed to switch out of their existing loans into these new FG-LTROs but retain the cheap fixed rate of funding they currently enjoy until 2021. After that, the interest rate on these new long-term loans would vary according to the prevailing policy rate set by the ECB. CONTINUE AT SITE
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