Christine Lagarde can face down ECB skeptics

Christine Lagarde has taken the helm of the European Central Bank (ECB) at a time of rising skepticism over the power of monetary policy. Critics say that the central bank has no tools left to bring inflation back to its target of close to, but below, 2%. The ECB is now a helpless bystander, they claim, as the power to foster a recovery sits squarely with elected governments.
There is little doubt that as the central bank digs deeper into its toolkit, some of its policies risk becoming less effective. But there is plenty more the ECB can do, from further rate cuts to more flexible asset purchases. And while the question over what to do next is largely political, Lagarde’s efforts to listen before she leaps and address tensions within the governing council head-on should provide a clean slate from which to take any difficult decisions down the road. The defeatist case against the ECB starts from how far the central bank has already gone. In September, it cut the deposit rate to -0.5% and restarted net asset purchases. For some, that means the central bank can’t cut rates further without harming the economy. What’s more, within roughly a year, the ECB could hit its own
self-imposed limits on its program of quantitative easing.
Of course, the more the central bank presses on monetary accelerator, the harder it is for its measures to push up inflation rate and stimulate growth. But economists at ECB still have tools they can use. For a start, they know they can lower deposit rate further. An ECB working paper shows that negative rates have not dissuaded savers from storing their money in a bank. Moreover, when banks passed sub-zero rates on to corporations, it’s sparked them to increase their investment — which is the point of the policy. There are legitimate concerns over risks to financial stability, but these can be addressed via other levers, including higher loan-to-value ratios.
The concerns over quantitative easing are also overblown. The ECB has decided it will purchase bonds according to each country’s shareholding in the central bank and will not hold more than a third of any euro-zone country’s sovereign debt. As Germany’s public debt shrinks, and the central bank purchases more securities, the limit of how many bunds it can hold risks becoming binding soon. But the ECB has shown itself to be flexible in the past in terms of how precisely it needs to stick to some of these self-imposed constraints.
Since becoming ECB president at the start of November, Lagarde has not yet expressed any views on the future of monetary policy. How far the central bank needs to go will of course depend on the strength of the euro-zone economy, which is showing some early signs of stabilisation after a terrible year. Yet, if further action is needed, the limits to what the ECB can do are largely political. It will be up to the new president to decide how far to go, and then rally the members of her governing council, even the most recalcitrant ones, to back the best path to get there.

—Bloomberg