The corona crisis has caused economic havoc in the euro countries. Some 1,000 billion euros of economic production has been lost. Governments have rigged up support measures worth hundreds of billions. And to make matters worse, inflation and consumer prices are falling, a symptom of a very weak economy.
So a lot of worries for the European Central Bank (ECB). The board meets today to discuss how to further tackle the corona crisis.
At the start of the corona crisis in March, the ECB jumped into the breach at an unprecedented speed and firmly with a buy-back programme. The ECB bought up 1350 billion euros of government debt. Helping everyone else get up to speed is difficult. It doesnt help that the interest rate is already at zero and there has just been a gigantic debt buy-back programme of 2,500 billion euros for the previous crisis.
Because of the corona crisis, less is built, produced, delivered and bought. The corona crisis is deeply a crisis of demand. There is no scarcity or shortage of goods and services, it is not an oil crisis or disaster, but people buy less. Not because there is no income, but because people cannot, dare and do not want it. Uncertainty about jobs and income also makes people cautious and frugal.
All this depresses the prices of goods and services and therefore also the turnover and earnings of companies. Inflation turns into deflation, exactly what the ECB does not want at all. Inflation in the eurozone was minus 0.2 percent in August. Lower prices may sound nice and cheap, but they are actually a symptom of a not functioning economy.
The main objective of the ECB is to monitor inflation, consumer prices. Ideally, inflation in a healthy economy should be between 1.5 and 2 percent, but the ECB has not been able to do that for years. And now the central bank looks again in the eyes of the deflationary ghost: falling consumer prices.
Inflation in the eurozone has been peaking and falling since 1997. Deflation is not unique; in April 2016, January 2015 and July 2009 consumer prices also fell, but always for short periods of time.
As long as the virus persists and society and economy are kept small by keeping a distance and 1.5 meter rules, economic activity will remain low.
The ECB cannot simply prevent this, says ING economist Carsten Brzeski. The ECB has helped prevent a possible new euro crisis and a credit crunch, and created confidence in the financial markets, but the real recovery has to come from governments and fiscal policy
The central bank can pump money endlessly, but the market already seems quite saturated. More money doesnt do that much anymore. Every day around 500 billion euros from banks lie unused at the ECB. The excess liquidity, the money on top of the required reserves of central banks, has swelled to almost 3000 billion euros thanks to the buy-back programmes and is growing by the day.
What can or should the ECB still do?
Although the ECB has already pulled out all the stops, it can still turn a few knobs, such as buying up more and faster debt and lowering interest rates. But the chance that the ECB is not doing anything yet is bigger. Lagarde will probably present lower inflation expectations, partly due to the stronger euro of the past period and the impact of the corona crisis, but also keep the gunpowder dry given all the uncertainty about the state of the economic recovery, thinks ING economist Bert Colijn.
The central bank is heading for inflation expectations, the expected movement in inflation over the next two years, rather than the daily rates, last months inflation. The ECB has already had to revise that inflation forecast downwards considerably. The ECB expects inflation to be 0.3 percent this year, 0.8 percent in 2021 and 1.3 percent in 2022. Mile away from the policy goal of less than but close to two percent.
According to Brzeski, the ECB should at least ensure that the money supply is not turned off too quickly. Otherwise, the eurozone runs the risk of the euro becoming even more expensive against other currencies, which is bad for the economy and inflation
And if all that doesnt help, well talk about helicopter money again. The idea of helicopter money is that citizens get their hands on money directly. The ECB would do better to keep that idea for the next crisis.