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Draghi Announces Purchases of Asset-backed Securities to Expand ECB Balance Sheet

Nov 06,2014  Market News  Comment: 0

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Philadelphia, Pennsylvania – (StockNewsDesk) – 11/06/2014 — Amid calls for bold action from ECB officials from many around the world concerned with the rapid deceleration of the European economy, Mario Draghi came out firing, announcing a plan to purchase asset-backed securities for two years. Additionally, he clearly stated concerns that inflation expectations had not materially improved, continuing to slide lower, despite modest stimulus efforts in the summer. European markets were up more than 1% on the news, with the euro hitting a two year low.

Draghi v. Weidmann

The largest source of conflict within the ECB is between the doves, led by chairman Mario Draghi, and the hawks, led by the head of Germany’s central bank, the Bundesbank. Draghi has been quite outspoken in his public statements about the need for fiscal and monetary stimulus in order to reverse the slide in the economy towards deflation and negative growth. Today’s statement implies that the doves are winning the debate, no doubt buttressed by recent economic data, which shows a bleak picture.

Most German officials believe the true solution lies in austerity and improved discipline in spending rather than borrowing money. Germany is wary of the threats of hyperinflation due to its past experiences, of course austerity is brutal in the short term for countries already struggling with a lack of demand. Therefore, it tends to be skeptical about monetary easing, and takes pride in the country’s consistent balanced budget.

Further complicating the picture is the rise of anti EU sentiment in Germany, as much of the German public sees itself subsidizing the entire European project. This has created pressure on German officials not to give in so easily to projects or measures that are seen as bailing out the rest of the Eurozone. This has resulted in German premier Angela Merkel’s public dismal of any sort of fiscal stimulus.

Draghi Announces Purchases of Asset Backed Securities to Expand ECB Balance Sheet

Central Bank Based Policy

The decision by the ECB to expand its balance sheet, which has been on the decline over the last few months, has affirmed the notion that the financial world continues to be run by central banks. Now, both the Bank of Japan and the ECB are aggressively expanding their balance sheets; this effectively increases asset prices and boosts inflation expectations by reducing the number of assets in circulation.

While the US central bank has ended its QE program, it continues to hold $3.6 trillion in assets on its balance sheet, with no intention of decreasing this number. Many hawks do not believe in the efficacy of these programs, while the doves argue that the real problem is that these programs have lacked the necessary boldness. However, the truth of the matter is that as long as inflation remains suppressed, there is no real check on central bank actions. Given the weakness across the board in commodities, inflation will not be a threat any time soon.

Draghi in Charge

There have been rumors swirling that Mario Draghi’s job was in jeopardy, due to the hawks being fazed by his focus on stimulus, both monetary and fiscal. Additionally, elected politicians did not take kindly to his lecturing them on how they should manage their budgets. At the same time, doves are being frustrated by the lack of aggressive ECB action.

This statement clearly reveals that Draghi remains in charge of the ECB, as he has bided his time patiently to build consensus. Ideally, he would have liked to act earlier, but he realized that such action would only be possible if economic data was bad enough. Now, the focus will shift to European inflation expectation, to see whether these measures are sufficient to stem the decline in the European economy.

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