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Posts Tagged ‘ECB’

OECD Deflation

January 7, 2015 Leave a comment

In 2014, 9 of the 34 members of the OECD experienced deflation whilst 3 others had zero inflation. Over the whole area consumer prices rose by only 1.7% mainly due to the fall in oil prices.

However in the Euro area inflation was only 0.4% over the year which is worrying especially as the European Central Bank (ECB) targets an annual rate of 2%. With interest rates at the ECB at 0.05% there is little scope for any stimulatory activity to increase inflation. Furthermore they are also charging banks deposits on money in the bank through a negative rate of 0.2%. Although lower oil prices will benefits businesses and consumers alike it maybe paradoxical if people expect lower inflation as cheaper energy pushes the headline rate into negative territory. So, the ECB has taken a leaf out of the US Fed’s book and decided on a form of quantitative easing by purchasing covered bonds and asset-backed securities.

Mario Draghi, President of the ECB, has not ruled out using additional measures “should it become necessary to further address risks of too prolonged a period of low inflation”.

Although Japan has an annual rate of inflation of 2.9% this has been largely due to an increase in the retail sales tax – if you exclude it from the calculation the inflation rate would be 0.9%. The Japanese Central Bank has a target of 2% inflation. As with the ECB interest rates in Japan are very low – 0.1% – so this leaves no scope for any stimulatory cuts. They are hoping that a further stimulus package of ¥3.5 trillion (NZ$ 37.41billion) on 27th December will boost the economy.

In New Zealand the annual inflation rate in September was 1% – the Reserve Bank Act 1989 stipulates a band of 1-3% while targeting future inflation at 2%. Unlike their counterparts at the ECB and the Bank of Japan they do have scope for stimulatory cuts as the official cash rate is currently 3.5%.

Deflation OECD

Categories: Deflation Tags: , , ,

Deflation fears on the agenda once more

October 19, 2014 Leave a comment

Deflation has emerged as a major risk to the global economy with it being particularly evident in Europe and Japan where leaders have found it hard to come up with any solutions to generate economic growth. In Europe inflation was just 0.3% in September well below the 2% target of the European Central Bank. With this low rate any weakness in the Germany economy could tip the Euro economy over the edge into a deflationary downturn. The extent of the concern with deflation was evident by the ECB’s record low interest rates – 0.05% – and a negative rates for deposits. With austerity measures in place in France and Italy one wonders about their ability to bring about any sort of growth and ultimately some mild inflation.

Deflation Oct 2014

Why is deflation a concern?

1. Holding back on spending: Consumers may opt to postpone demand if they expect prices to fall further in the future

2. Debts increase:

• The real value of debt rises when the general price level is falling and a
higher real debt mountain can be a drag on confidence
• Mortgage payers on fixed mortgage interest rates will see the real cost of servicing their debt increase

3. The real cost of borrowing increases: Real interest rates will rise if nominal rates of interest do not fall in line with prices

4. Lower profit margins: This can lead to higher unemployment as firms seek to reduce their costs.

5. Confidence and saving: Falling asset prices such as price deflation in the housing market hit personal sector wealth and confidence – leading to further declines in AD. Higher savings can lead to the paradox of thrift

Source: Tutor2u

Categories: Deflation Tags:

Deflation threat for Euro area

January 17, 2014 Leave a comment

Today inflation in the Euro area is at dangerously low levels – 0.8% in the year to December. This is well below the target of 2% set by the European Central Bank. It doesn’t help that unemployment in the area is 12.1% and this will need to fall if there is to be some sort of recovery which will put upward pressure on prices. The ECB cut its Main Refinance Rate to 0.25% on 13th November last year and could be running out of options. It might be looking at imposing negative interest rates on deposits held at the ECB by trading banks.

Euro Area Inflation

Why is deflation a concern?

1. Holding back on spending: Consumers may opt to postpone demand if they expect prices to fall further in the future

2. Debts increase:

• The real value of debt rises when the general price level is falling and a
higher real debt mountain can be a drag on confidence
• Mortgage payers on fixed mortgage interest rates will see the real cost of servicing their debt increase

3. The real cost of borrowing increases: Real interest rates will rise if nominal rates of interest do not fall in line with prices

4. Lower profit margins: This can lead to higher unemployment as firms seek to reduce their costs.

5. Confidence and saving: Falling asset prices such as price deflation in the housing market hit personal sector wealth and confidence – leading to further declines in AD. Higher savings can lead to the paradox of thrift

Source: Tutor2u

Categories: Deflation, Euro, Inflation Tags:

ECB contemplating negative interest rates.

May 5, 2013 Leave a comment

negativeinterestRecently the European Central Bank cut its refinancing rate by 25 basis points to 0.5% which is a record low. The catalyst for this rate cut was the continuation of the decline in the manufacturing sector of the EU. Although this lower interest rate did improve the mood of investors ECB President Mario Draghi did hint at the prospect of negative interest rates on deposits at the ECB. This would mean that trading banks would pay for the privilege of parking their money in the ECB. What are the options for banks?

1. The ECB’s thinking is that banks wouldn’t want to pay interest to the ECB and therefore would try and lend money to consumers which would stimulate growth in the real economy.
2. The banks could stop depositing money at the ECB and simply keep it themselves – like a consumer you would keep money ‘under your mattress’.
3. The banks could continue to deposit money at the ECB and pass on the cost of negative interest rate to the consumers who borrow. This would likely reduce the level of borrowing which is exactly what the ECB don’t want.

With the US economy starting to grow is QE a more applicable policy instrument for the EU economy? Will Draghi follow Bernanke? Its seem that he is not keen on the ‘helicopter drop’ but with a 0.5% refinance rate what other options are available?

Categories: Interest Rates Tags:

QE3 and ECB bond purchase is not the elixir for recovery – Stiglitz

October 14, 2012 Leave a comment

Nobel Laureate Joseph Stiglitz came out strongly against the recent QE3 by the US Fed and the ECB’s announcement that it would buy government bonds of indebted eurozone member countries. With this announcement stock prices in the US reached post-recession highs although some worried about future inflation and significant government spending. According to Stiglitz these concerns are unwarranted as there is so much underutilisation and no serious risk of inflation. But the US Fed and the ECB sent three clear messages:

1. Previous actions didn’t work – ie QE1 and 2
2. The US Fed announcement that it will keep rates low until 2015 and buy $40bn worth of mortgage backed securities suggested the recovery is not going to take place soon.
3. The Fed and the ECB are saying that the markets won’t restore full employment soon – fiscal stimulus is needed.

In textbook economics increased liquidity means more lending, mostly to investors thereby shifting the AD curve to the right and thereby increasing demand and employment. But if you consider Spain an increase in liquidity will be cancelled out by an austerity package.

For both Europe and America, the danger now is that politicians and markets believe that monetary policy can revive the economy. Unfortunately, its main impact at this point is to distract attention from measures that would truly stimulate growth, including an expansionary fiscal policy and financial-sector reforms that boost lending. Joseph Stiglitz

WSJ Graphic – Central Bank Interest Rates

August 6, 2012 Leave a comment

If you are teaching monetary policy in any course the graphic below shows a significant expansionary monetary policy. Remember in New Zealand the RBNZ changes interest rates to influence the level of economic activity in order to achieve price stability. Note the following:

• Implementation of monetary policy is one of the roles of the RBNZ
• The Reserve Bank Act established “price stability” as the main objective of the RBNZ. The RBNZ is therefore responsible for achieving “price stability”
• “Price stability” is defined in the PTA (Policy Target Agreement) as keeping inflation between 1 to 3% (measured by the percentage change in CPI)

In order to stimulate the economy the ECB cut benchmark interest rates to 0.75%. Chinese authorities cut one year yuan lending rate to 6% (still has ammunition left). The Bank of England reduced rates to 0.5%. This is in the hope that businesses will use the cheaper sources of credit to invest in their business and therefore create jobs. Lower rates would also ease the burden of those on floating interest rates.

ECB has ‘some’ cash to inject into monetary system

August 3, 2012 Leave a comment

ECB President Draghi has insinuated that there is a lot more ammunition to be fired. Draghi was determined to build on his comments in London last week when he pledged to do ‘whatever it takes’ to save the euro. He says that ‘financial fragmentation’ as hindering the monetary transmission mechanism. However, his key point was the ‘risk premia that are related to fears of the reversibility of the euro are unacceptable, and they need to be addressed in a fundamental manner.’

In order to create the fundamental conditions for such risk premia to disappear, policy-makers in the euro area need to push ahead with fiscal consolidation, structural reform and European institution-building with great determination. As implementation takes time and financial markets often only adjust once success becomes clearly visible, governments must stand ready to activate the EFSF/ESM in the bond market when exceptional financial market circumstances and risks to financial stability exist – with strict and effective conditionality in line with the established guidelines. Source: BNZ

The graph below shows that the ECB have a bit of cash.

Categories: Euro, Financial Markets Tags:
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