More than three years after the financial crisis that erupted in 2008, who is doing more to bring about economic recovery, Europe or the US?
The US Federal Reserve has completed two rounds of so-called “quantitative easing,” whereas the European Central Bank (ECB) has fired two shots from its big gun, the so-called long-term refinancing operation (LTRO), providing more than 1 trillion euros (US$1.3 trillion) in low-cost financing to eurozone banks for three years.
For some time, it was argued that the Fed had done more to stimulate the economy, because, using 2007 as the benchmark, it had expanded its balance sheet proportionally more than the ECB had done. However, the ECB has now caught up. Its balance sheet amounts to roughly 2.8 trillion euros, or close to 30 percent of eurozone GDP, compared with the Fed’s balance sheet of roughly 20 percent of the US’ GDP.
However, there is a qualitative difference between the two that is more important than balance-sheet size: The Fed buys almost exclusively risk-free assets (such as US government bonds), whereas the ECB has bought (much smaller quantities of) risky assets, for which the market was drying up. Moreover, the Fed lends very little to banks, whereas the ECB has lent massive amounts to weak banks that could not obtain funding from the market. In short, quantitative easing is not the same thing as credit easing.
The theory behind quantitative easing is that the central bank can lower long-term interest rates if it buys large amounts of longer-term government bonds with the deposits that it receives from banks. By contrast, the ECB’s credit easing is motivated by a practical concern: Banks from some parts of the eurozone — namely, from the distressed countries on its periphery — have been effectively cut off from the interbank market.
A simple way to evaluate the difference between the approaches of the world’s two biggest central banks is to evaluate the risks that they are taking on.
When the Fed buys US government bonds, it does not incur any credit risk, but it is assuming interest-rate risk. The Fed acts like a typical bank engaging in what is called “maturity transformation:” It uses short-term deposits to finance the acquisition of long-term securities. With short-term deposit rates close to zero and long-term rates at about 2 percent, the Fed is earning a nice “carry,” equal to about 2 percent per year on bond purchases totaling roughly US$1.5 trillion over the course of its quantitative easing, or about US$30 billion.
Any commercial bank contemplating a similar operation would have to take into account the risk that its cost of funds increases above the 2 percent yield that it earns on its assets. The Fed can determine its own cost of funds, because it can determine short-term interest rates. However, the fact that it would inflict losses on itself by increasing rates is likely to reduce its room for maneuver. Its recent announcement that it will keep interests low for an extended period thus might have been motivated by more than concern about a sluggish recovery.
By contrast, the ECB does not assume any maturity risk with its LTRO, because it has explicitly stated that it will charge banks the average of the interest rates that will materialize over the next three years. However, it does take on credit risk, because it is lending to banks that cannot obtain funding anywhere else.
The large increase in the ECB’s balance sheet has led to concern that its LTRO might be stoking inflation. However, this is not the case: The ECB has not expanded its net lending to the eurozone banking system, because the deposits that it receives from banks (about 1 trillion euros) are almost as large as the amounts that it lends (1.15 trillion euros).
This implies that there is no inflationary danger, because the ECB is not creating any substantial new purchasing power for the banking system as a whole.
The banks that are parking their money at the ECB (receiving only 0.25 percent interest) are clearly not the same ones that are taking out three-year loans at 1 percent. The deposits come largely from northern European banks (mainly German and Dutch) and LTRO loans go largely to banks in southern Europe (mainly Italy and Spain). In other words, the ECB has become the central counterparty to a banking system that is de facto segmented along national lines.
The real problem for the ECB is that it is not properly insured against the credit risk that it is taking on. The 0.75 percent spread between deposit and lending rates — yielding 7.5 billion euros per year — does not provide much of a cushion against the losses that are looming in Greece, where the ECB has 130 billion euros at stake.
The ECB had to act when the eurozone’s financial system was close to collapse at the end of last year. However, its room for maneuver is even more restricted than that of the Fed. Its balance sheet is now saddled with huge credit risks over which it has very little control.
It can only hope that politicians deliver the adjustments in southern Europe that would allow the LTRO’s recipient banks to survive.
Daniel Gros is director of the Center for European Policy Studies.
Copyright: Project Syndicate
Since COVID-19 broke out in Taiwan, there has been a fair amount of news regarding discrimination and “witch hunts” against medical personnel, people under self-quarantine and other targets, such as the students of a school where an infection was discovered. Quarantine breakers are almost certainly on the loose and it is only natural for people to be vigilant. One in Chiayi was found by accident at a traffic stop because his helmet was not fastened. However, those who follow the rules by quarantining themselves should be encouraged to keep up the good work in a difficult situation, instead of being
Chinese Nationalist Party (KMT) Legislator-at-large Wu Sz-huai (吳斯懷) has said that there is a huge difference between Chinese military aircraft circling Taiwan along the edges of its airspace and invading Taiwan’s airspace. He also said that whether it is US or Chinese aircraft flying along or encircling Taiwan’s airspace, there is no legal basis to say that such actions imply a clear provocation of Taiwan, and asked the Ministry of National Defense not to mislead the public. People who hear this might think that it is not a very Taiwanese thing to say. US military activity in the vicinity of Taiwan
As the nation welcomes home Taiwanese who had been stranded in China’s Hubei Province — arguably one of the most dangerous places on Earth since the novel coronavirus outbreak began in its capital, Wuhan, late last year — problems surrounding the “quasi-charter flights” that brought them back have been largely overlooked. The media used the term to describe the two flights dispatched by Taiwan’s state-run China Airlines because they do not count as charter flights. Taiwanese wanting to board those flights had to travel — most likely by train — more than 1,000km from Hubei to Shanghai Pudong International Airport
Burger King Taiwan on Wednesday last week posted an update on Facebook advertising a new “Wuhan pneumonia” (武漢肺炎) home delivery meal, catering to customers hankering for a Whopper, but who wished to avoid visiting one of its outlets. “Wuhan pneumonia” is the term commonly used in Taiwan to describe COVID-19. Beijing has been waging an extensive propaganda campaign against the use of the words “Wuhan” or “China” in reference to the novel coronavirus, calling it racist and discriminatory. Meanwhile, Chinese officials have claimed that the coronavirus might have originated in the US. The intention is obvious: to distract attention from the Chinese Communist