Overall it seems unlikely that these measures will be enough to reach the expansion target now openly pursued from the ECB. That is why more and more analysts and investors think that a ‘public QE’, i.e. a “broad asset purchase programme”, as defined from the ECB itself in the past, involving which would involve sizable government bond purchases launched at some stage.

Are these unconventional measures going to work?

For sure all the liquidity pumped in the system (a more evident case can be seen in the various QE programs from the Fed) have been working in keeping a bid under government bonds (especially peripheral ones), equities (especially in the financial sector) and corporate bonds (especially banks’ issues).

But whether the real plan to provide liquidity either to be ‘pulled’ from (T-LTROs) or to be ‘pushed’ into the private sector (ABS and Covered Bonds purchase programmes) is going to work or not, is something I’m definitely more skeptical about.

Along these difficult years after the great financial crisis, one of the most lucid templates, in order to analyze the behavior of a deleveraging economy after the explosion of a credit bubble, has been the one provided from Richard Koo. His ‘balance sheet recession’ interpretative scheme is now well known and often well understood and valued. I completely subscribe his recent words on the topic and I will make an extensive use of them since they could be so much clearer and to the point than anything I could add.

“The next question is whether these measures will actually drive improvements in the economy. The answer, unfortunately, is almost certain to be no. There is little reason why monetary policy should have any impact in the Eurozone, which is currently in the midst of a severe balance sheet recession.

If the Eurozone still had industries or sectors capable of responding to low interest rates, they would have done so long ago. The fact that the steady stream of rate cuts has done nothing to stimulate the economy makes it clear that interest rate-sensitive sectors have been paralyzed by damaged balance sheets. In such cases, there is no reason why rate cuts should have any impact.

Although the purchase of ABS and covered bonds may allow the ECB to distribute funds to financial institutions, the central bank cannot coax these funds out into the real economy as long as potential borrowers are immobilized by their balance sheet problems.

This was demonstrated two years ago, when the ECB supplied more than €1trn in liquidity via two long-term refinancing operations (LTROs) at the end of 2011 and the beginning of 2012. Such injections of funds are very effective and necessary when mutual mistrust between financial institutions resulted in huge funding problems for these institutions.

But now that financial institutions are no longer experiencing such difficulties, they have returned the funds to the ECB since there is little demand for funds from the real economy.

If we take the monetary base at the time of the Lehman failure to be 100, it rose to 196 after the two LTROs, but recently eased back to 132 as banks have regained trust in each other.

The ECB president noted at his press conference that Eurozone lending to nonfinancial corporations was falling at an annualized rate of 2.2%, in large part because of debt repayments (“net redemptions”).  

The salient characteristic of any balance sheet recession is that companies begin paying down debt in spite of zero interest rates. There is no reason why monetary policy should have any effect on the economy at a time when a shortage of borrowers is the main bottleneck.

In the Eurozone there are many who do not understand even this most basic of notions— that monetary policy does not work when there are no borrowers.”

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