European Central Bank President Christine Lagarde was France’s finance minister during the 2008 financial crisis. Later, she became managing director of the International Monetary Fund. Given her experience, her instincts in confronting coronavirus and the shock to the euro area’s economy will be to shoot high and go big. She will want to be seen as a European leader doing ‘whatever it takes’.
But Lagarde faces a dilemma. She knows that the ECB cannot act alone, and that decisive fiscal action would be far more potent than monetary policy measures.
Her ‘owlish’ eyes at the 12 March ECB governing council meeting will not just be on Frankfurt, but on Berlin and other European capitals. The ECB will act. But coronavirus has given her a golden opportunity to push European Union member states to step up on fiscal policy – what some have even called a ‘grand bargain’ between monetary and fiscal policy.
The ECB’s options are constrained. Coronavirus is both a supply and demand shock, and monetary policy is not well equipped to deal with supply shocks. Euro area monetary policy is already overburdened and near the effective lower bound. In the euro area’s current economic circumstances, firms and households may require liquidity and other financial support to be tided over through the coronavirus crisis. Banks too may need funding help. Lower rates might be able to play a limited role in supporting confidence and asset prices.
Accordingly, many analysts predict the ECB will offer cheaper targeted longer-term refinancing operations if funding is aimed at firms and households facing liquidity constraints. They also cite a range of other options, suggesting that the ECB may step up its asset purchases and cut its deposit rate by a further 10 basis points. Other proposals involve tiering and debates about relaxed bank supervisory guidance to help household and firms deal with a liquidity squeeze.
Lagarde will want to see a consensus behind the ECB’s actions. Balancing ‘hawks’ and ‘doves’ may impact the contours of the ECB’s actions.
More significantly, the euro area has long needed to rebalance its fiscal and monetary policy mix, and take pressure off monetary policy. Lagarde has well known this for years.
At the IMF, she called for Germany and other European countries to judiciously use their fiscal space. She also called on Brussels to develop a centralised fiscal capacity, as well as take other steps to bolster the euro area, such as by strengthening banks and creating a European deposit insurance system. The Fund criticised the excessive complexity of European fiscal rules.
Since her nomination to the ECB presidency, her speeches have consistently hammered this point home. The ECB board is behind her on this argument. Further, multiple reports cite Lagarde telling European leaders on a conference call this week that without coordinated action, Europe will see a situation akin to the 2008 financial crisis.
A smart and talented financial diplomat and politician, Lagarde will press her advantage. She will argue for stepped up euro area fiscal policies and stronger European institutions in return for ECB action. Already, Chancellor Angela Merkel has seemingly backed off Germany’s ‘black zero’ budget policy for the time being. However, the jury is out on whether European leaders will step up, act decisively, and stop looking to the ECB to be the only game in town.
Mark Sobel is US Chairman of OMFIF.