Monday, June 11, 2012

The ECB is Passively Tightening

Something that many observers miss about the Eurozone crisis is that by doing nothing the ECB is doing something: it is passively tightening monetary policy.  Total current Euro spending is falling, either through a endogenous fall in the money supply or through a decrease in velocity, and the ECB is failing to respond to it.  The impact of passive tightening is no different than that of an overt tightening of monetary policy. Currently it is tearing the Eurozone apart.

Michael Darda sees this passive tightening by the ECB and is not impressed:
European markets quickly ran out of steam today on news of a Spanish bank recapitalization over the weekend. Part of this may be due to the fact that  equity markets already discounted the news last week. Moreover, the ECB took a pass on a relatively costless (in our view)  opportunity to surprise to the upside with  even symbolic  monetary stimulus (rate cut,  anyone?). Given the ongoing pressure on Spanish and Italian sovereign debt markets—and the correspondingly level of regional inflation expectations—the Spanish bank recapitalization is highly  unlikely to be enough to set the eurozone on  a more robust growth trajectory. Indeed, we do not believe additional EFSF/ESM measures will be effective unless they are coupled with a much more  accommodative ECB monetary policy (i.e., one that provides for faster euro-area nominal GDP growth). The key here is for the ECB to manage expectations properly. Closed-ended, ad hoc actions that are limited in scope are not likely to bear fruit, as increases in base money get  absorbed by  falling base velocity. A more open-ended and aggressive commitment to reflationary policies, however, would likely require the ECB to do less with its balance sheet, as market forces would help the ECB ease. Although we believe ECB President Mario Draghi got off to a good start, we are not  encouraged by recent statements  and the lack  of  follow-through at a critical juncture for the eurozone.
Passive tightening is fashionable these days.  It is being done of both sides of the Atlantic.

Update: Jim Pethokoukis agrees with Michael Darda.


  1. anything that does not involve "massive ECB intervention" will be a failure. they cannot even decide how to fund it and the Spanish "firewall" will not be in place until the end of the month by which time the fore will have spread well beyond Spain. I have my doubts that the damage is reversible after June 17th.

  2. dwb- What's the significance of June 17th in particular? I have difficulty imagining a successful scenario right now. The Spanish bank bailout just made it a bit worse.

  3. Greek elections, but pick your own date in June. people are not paying their taxes in Greece in preparation for a potential greek exit; at some point Greece hits a wall and can't pay the bills. I am pretty sure Greece will have to drop the Euro. The question is how bad the fallout will be. Reading about all the various cultural differences in Europe does not give me a good feeling.

  4. "Unintentional tightening" might be a more appropriate term than "passive tightening." For one thing, the distinction between *intending* and *not intending*, while not perfectly sharp, is a lot clearer than the distinction between *action* and *passion*--between *doing something* and *doing nothing*.