While the ECB just tuned a loan of €82,6 billion to banks, the Organization for Economic Cooperation and Development (OECD) has put on paper what the data had been suggesting for several weeks: the euro area is struggling to restart, unemployment does not drop and investments do not start.
In the last six years, the European Central Bank has intervened with various monetary policy measures which have prevented the explosion of systemic risk and the collapse of the financial system, as well as having allowed banks to recapitalize themselves and relieved governments of spread pain. Since June, however, we have entered one new phase of the ECB's strategy, which consists of revitalize the credit channel to support economic growth.
What measures has the ECB taken?
1. Targeted long-term refinancing operations (TLTRO)
With this operation the banks will be able borrow money from the ECB in the medium to long term (expiration 2018) to subsidized rates (0,15%), provided the funds finance businesses and families.
Banks will therefore have to demonstrate that they are using the money for this purpose, otherwise the funds will be returned two years before the scheduled expiry (four years). The first phase of the operation began on 18 September, involving 255 financial institutions and allocating resources for a total amount of €82,6 billion. Subsequently, banks will be able to request additional funds on three other occasions: December 2014, March 2015 and June 2016. According to analysts, in 2014 banks will request funds for a total amount of €575 billion.
2. Decrease in benchmark interest rates
The interest rates with which the ECB influences the market are now close to zero and more than that they can't go down. With this move, the central bank is sending a message to financial institutions: don't expect any more interest rate action, but finance your credit operations with the program TLTRO.
3. Private Sector Asset Purchase Program (ABS)
Da October the ECB will be able to purchase particular bonds (ABS and covered bonds) which will potentially allow banks to get rid of some "uncomfortable" bonds and to sell them on the market, developing a market which in fact is of little importance in Europe.
What is their impact on the economy?
The interactions between finance and the economy take place within a complex system, where the variables involved are so numerous as to make it difficult to understand who influences what. Also, the mix of unconventional policies in recent years complicated the frame of reference traditional. But let's try to shed some light on the matter.
Central banks interact with financial markets by changing interest rates and influencing the prices of bonds and stocks (remember the interest rate curve?), which in turn transfer these impulses to thereal economy (production, employment and investment).
With this simplified scheme in mind, we reviewed i mechanisms through which the ECB hopes to support growth with the recent three monetary policy measures.
The goal is to explain what Draghi is doing to everyone, even those less experts in economics and finance.
Interest rate cut
What happens on the markets
1. The cost of money is reduced: banks lend each other money at lower rates.
2. Bond yields go down (think of yields on BTPs), prices increase inversely.
3. Stock market quotations are on the rise. investors anticipate a lower cost of capital which, with the same expectations on profits and revenues, allows shareholders to have a higher return on invested capital.
4. Depreciation of the exchange rate: Since lending money is less convenient, investors move their capital elsewhere, causing the national currency to depreciate (think of the euro against the dollar in recent weeks).
Consequences on the real economy
. Il financial system has an incentive to disburse credit: Banks can finance themselves at advantageous rates and increase their profitability; The increase in share prices favors the financial climate and the capitalization of banks; The increase in bond prices improves the bank's assets (think of how many BTPs are held by the Italian banking system) and its profitability.
. Le companies production, investments and employment increase: The lower cost of money encourages companies to invest; The lower cost of borrowing reduces the interest expense of companies and improves their income statement; The increase in share prices improves the capital base of companies and encourages new listings; The depreciation of the exchange can favor exports and improve the revenues and profitability of companies.
. Le families they can go back to consuming or buying a house: Families finance themselves at a lower cost (mortgages and consumer credit). Furthermore, cutting rates can affect consumption and saving decisions: with low interest rates, households may have a greater incentive to consume rather than save; Improved corporate profitability can foster employment and raise wages; The increase in the prices of financial assets improves the financial wealth of households.
TLTRO
What happens on the markets
1. Stock prices rise.
2. Bond yields are down.
Consequences on the real economy
. Il financial system has an incentive to increase credit: banks borrow at low rates and have to use them in the real economy, increasing their profitability.
. Le companies production, investments and employment increase: Firms are encouraged to invest thanks to the lower cost of money; The lower cost of borrowing is also transferred to the income statement of companies, reducing interest expenses; The increase in share prices improves the capital base of companies and encourages new listings.
. Le families they can go back to consuming or buy a house. The expansion of credit and the improvement in the general economic situation can have positive effects on employment and wages, stimulating household consumption and investment.
ABS purchase programme
What happens on the markets
The demand for these bonds increases, yields go down (and prices go up).
Consequences on the real economy
. Financial system has an incentive to increase credit: Banks can get rid of some "uncomfortable" assets, improve the quality of their balance sheets and therefore set aside less risk capital, which can thus be allocated to credit; Investors have new investment tools; Banks can conclude new credit agreements, which will then be sold on the market.
. Le companies increase production, investments and employment. By revitalizing the ABS market, new credit channels are created for companies, to the advantage of the expansion of their business.
. Le families they can go back to consume or buy the house. The improvement in the economy will probably stimulate household consumption and investment.
The strategy of the ECB
The ECB's objective is clear: by facilitating the provision of credit toreal economy, hopes to stimulate the economic growthby encouraging the investments, favoring theoccupation , production, with probable positive effects on consumption.
But the ECB's actions have to deal with an unknown factor: the willingness of businesses and citizens to use the money. And this also depends on factors independent of monetary policy decisions.
