Draghi’s Difficult Dance
Draghi’s clever Jackson Hole speech unleashed financial market expectations of additional stimulus measures at Thursday’s meeting. However, the situation is complicated. Thus, numerous interpretations have unfolded on what he signaled (or didn’t signal) and on what types of ECB-led solutions are possible. Some pundits have argued that large-scale QE for Europe would do more harm than good. Regardless, markets are likely to be disappointed as the October meeting seems to be a more practical time for any announcement.
Draghi further complicated quarrels by saying that such a program would ultimately not be effective without action that occurs in parallel with fiscal changes. In his concluding remarks, for example, he said that ‘a coherent strategy to reduce unemployment has to involve both demand and supply side policies, at both the Euro area and the national levels.’ (some have referred to this as Draghi’s three arrows)
He was basically telling politicians that the stance of Eurozone fiscal policy needed to be re-examined. His New-Keynesian framework probably did not go over well in Berlin. It was leaked in the German press that Merkel called Draghi after his speech. He might have chosen to lecture politicians, because of his tacit acknowledgement that the economy is facing a liquidity trap; implied by his comment, ‘due to the zero lower bound constraint, there is a real risk that monetary policy loses some effectiveness in generating aggregate demand’.
Draghi is a savvy political operator. He is fully aware of the limitations and consequences of a sovereign debt QE program. He knows that a central bank’s willingness to purchase a country’s debt (in ‘whatever -it-takes’ quantities), basically places an implicit cap on the price of a country’s funding. Such a program rids a government of fiscal discipline, while simultaneously eliminating the spikes in yields that would normally result. Complacency or fiscal stalemate ensues; enabled specifically by monetary actions.
This post was published at Zero Hedge on 09/03/2014.