Welcome to the zero lower bound, Europe. We’ve been waiting for you!

May 2, 2013

Europe is a mess, with a handful of Southern European countries in depression and many of the other nations on the continent in recession. Inflation has been exceptionally low, even in economically strong Germany.

So it would be a good time for “Super Mario” Draghi to come to the rescue. The European Central Bank president didn’t quite deliver on Thursday—a quarter percentage point cut in target interest rates isn’t quite the salve that the 27 percent of Spanish workers who are unemployed might hope for. But in Draghi’s press conference following the meeting, it became clear that the central bank is starting to weigh some bigger and bolder things to try to get a monetary policy in place that will match the moment for Europe.


Negative interest rates? Maybe! (Hannelore Foerster/Bloomberg)

It took a while, but the ECB has finally reached a point that the Federal Reserve hit in December 2008 and the Bank of England hit in March 2009: The zero lower bound. Each bank defines differently the lowest it is willing to go in its short-term interest rate target (for the Fed that’s roughly 0.15 percent, for the Brits it is 0.5 percent). But with the ECB’s deposit rate now at zero, the Eurozone has joined the other Western central banks in an environment in which traditional, plain vanilla cutting of short-term interest rates isn’t an option. Welcome to the zero lower bound, ECB!

It is clear that there is a strong current of thought on the ECB’s governing council that they will need to do significantly more to ease policy, and soon. “We will look at all the incoming data and stand ready to act if needed,” Draghi said in his post-meeting press conference. What will that mean in practice?

One unconventional move beyond interest rate cuts already happened. In his press conference, Draghi said that the ECB will keep its programs to support bank lending in place until the middle of 2014. That is an ECB-esque form of what other central banks have done with “forward guidance,” of telling people how long a policy will remain in place as a way of getting extra economic benefit. That has most commonly happened with monetary policy, as when the Fed started announcing it expected to keep interest rates low until the end of 2014. The ECB is using the same approach with its support for the banking system. Think of it this way: Banks may be more comfortable extending loans (and thus supporting economic growth) if they have confidence that the ECB won’t yank away access to cash on favorable terms anytime soon. “There can’t be fears of a lack of funding as an excuse for not lending,” said Draghi.

On interest rate policy, the ECB appears open to moving in a direction that the other major central banks have not. A reporter asked Draghi if the central bank would consider a “negative deposit rate,” essentially charging banks for the privilege of parking money at the ECB. The idea is that if they paid some penalty for sitting on reserves, banks would have that much more incentive to lend it out to borrowers instead. It would be a step with few precedents (the only one I know of is a step by the Swedish Riksbank in 2009, which soon reversed its -0.25 percent deposit rate). There are plenty of technical challenges involved, including that banks may just keep more money in the form of paper banknotes in their vaults as opposed to reserves on deposit electronically, in order to try to avoid the fee.

But the concept is clearly on the table in Europe. “We will look at this with an open mind,” Draghi said.

That may be necessary because the ECB is more reluctant to use the policy tool that the Bank of England and Fed have favored while up against zero interest rates, of buying longer-term government bonds. You can’t rule out quantitative easing entirely for Europe, but that gets into some uncomfortable  territory. While Draghi has pledged to do “whatever it takes” to keep the Eurozone from unraveling, monetary policy is a different thing, and QE could mean buying government debt—which violates the spirit of the ECB’s founding documents—not to address an existential threat to the common currency, but as part of routine monetary policy. So that may be too much to handle, unless things get significantly worse.

The ECB has been persistently behind the curve as the Eurozone economy has entered a dire situation. What’s clear after Thursday’s meeting is that they’re at least trying to catch up, even if they aren’t there yet.

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