Failures of the ECB

I was writing a short piece on the functions of a Central Bank. The interesting thing is the extent to which the ECB is failing to carry out certain functions. This failure of the ECB threatens to undermine the whole EU economy.

Failures of

Ignoring Economic Growth. A Central Bank definitely has to target low inflation, but not to the exclusion of other macroeconomic objectives such as economic growth and unemployment. The ECB seem to give the impression that inflation is the only thing they care about. As the global economy was slowing down, the ECB increased interest rates this year. Yet, to keep inflation on target at the cost of a recession, is a pyrrhic victory - especially when the inflation is temporary anyway.

Unwillingness to Buy Government Bonds.

Why does the UK have low interest rates on government bonds, but countries like Italy and Portugal have much higher bond rates, despite similar levels of borrowing? Markets know the ECB wouldn't buy Italian bonds in a liquidity crunch. Even one month's shortage would cause great problems and therefore markets push up interest rates on Italian bonds. Occasionally, the ECB has bought bonds, but when they buy bonds they always do it with a loud feeling of guilt and they say they will reverse it as soon as possible. The ECB successfully lose any confidence the market may have in the operation. Paul De Grauwe explains in more detail at Vox

The impact of this decision, is that it puts greater pressure on European governments to pursue deflationary fiscal policy at a time when they need the opposite.

Unwillingness to Pursue Unconventional Monetary Policy

The ECB seem stuck in past economic situations. They don't seem to realise that in the Eurozone, especially south, there is a real threat of deflation and prolonged recession. Faced with this kind of crisis, a Central Bank should be galvanised to do everything in its power to avoid recession. This may mean a temporarily higher inflation target for countries in the north of Europe, it may mean unconventional monetary policies such as quantitative easing. But, the problem is they have an almost religious devotion to low inflation and can't see wider issues.

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