The compass and the anchor: the ECB’s communication muddle

Last week’s press conference was the second time less than 12 months that the European Central Bank’s (ECB’s) communication of a key policy initiative fell short. The first occasion, of course, was on 12 March last year, during the announcement of the EUR120 billion asset purchase program (APP) expansion, when President Lagarde insisted “we are not here to close spreads”—a comment that has the rare distinction of being footnoted and clarified in the transcript. Just 6 days later the Pandemic Emergency Purchase Program (PEPP) was rushed through, a program certainly designed to closed spreads.

The latest communication muddle again relates to ECB asset purchases, this time in the execution of expanded PEPP purchases. It arguably originates with the fact that the Governing Council is split on the need to fully use the EUR1,850 billion envelope. At the December announcement of the PEPP extension and expansion, it was clarified in the introductory statement that “if favourable financing conditions can be maintained with asset purchase flows that do not exhaust the envelope … [it] need not be used in full. Equally, the envelope can be recalibrated if required…”

This discussion was further illuminated in the account of the December meeting, published last week, where the PEPP is described as “the cornerstone of the Governing Council’s monetary policy package.” Still, the Governing Council was a split on its size. The discussion went on, with emphasis added, “preserving favourable financing conditions implied a move away from a constant monthly pace of purchases towards adjusting the pace according to market conditions… This approach, combined with forceful communication, could allow the Governing Council to reduce the pace of purchases while having an equivalent effect on financing conditions. This could result in greater efficiency and in using less than the entire envelope over the duration of the programme.”

Notwithstanding the acknowledged need for “forceful communication,” this policy was undermined unnecessarily last week in two ways. First, the caveat on the envelope not being used in full was added to the press release—hinting that this was a subject of continued emphasis at the Governing Council. Second, clarification during the press conference of what favourable financing conditions (FFC) means, to which PEPP is now explicitly linked, was confused to say the least. Consider Lagarde’s description:

“So how do we identify whether or not we are in the presence of favourable financing conditions? Well, I would say first of all that it is based on a holistic and multifaceted approach, our assessment, and it is intended for all sectors. So, all sectors means households, SMEs, corporates, sovereigns. And we look at the financing conditions and as a result of that we look at the bank lending rates. We look at the credit conditions, we look at the yields of corporates, yields of sovereigns, and it’s this composite approach and this multiple-indicators approach that we take into account to determine whether the financing conditions are favourable or not. But don’t forget that favourability is always assessed relative to inflation dynamics. So, we have to decide whether the financing conditions are appropriate to return inflation to its pre-pandemic path. So, those are really, I’d like to think in terms of this, the compass and the anchor and the two of them interact in order to assess whether or not we need to adjust and calibrate our purchases of any period. Because don’t forget that PEPP is intended to preserve the financing conditions, is earmarked by flexibility, and that flexibility, you’ve heard me say before, is flexibility along time sequences, flexibility in asset classes, flexibility in countries. And it has this dual function of stance and transmission as well. So, all that remains unchanged and the flexibility is still, you know, one of the key attributes of our PEPP.”

All the media and markets need are three reassuring words like “whatever it takes.” Instead, we’ve got “the compass and the anchor” and images of a quayside pub full of drunk sailors.

How has the ECB got itself into such a muddle? The simple answer is that the removal of automaticity of PEPP flows and explicit link to FFC has added a new concept in the conduct of policy—not a target that is easily defined let alone communicated.

But the deeper answer probably lies in Lagarde’s own description her job as ECB President during her first press conference in December 2019. At that time Lagarde took a moment to reflect on her more inclusive style of governing and willingness to reach over the heads of the press in communicating. Speaking directly to the gathered media, Lagarde noted how:

“…each and every President has his or her own style of communicating. I know some of you are keen to compare and rate or rank. I will have my own style. As I’ve said before, don’t over-interpret, don’t second-guess, don’t cross-reference. I’m going to be myself and therefore probably different… I have certainly made a point of my tenure to include members of the Governing Council and to seek their views and their consideration before any decision is made. I have huge respect for the work that you do. You are a main audience for the central bank. But you are not the only audience, and I would also encourage you not to try to draw too many conclusions or decisive findings from communication that I would address to a different audience with a slightly different language in order to be maybe better understood by those who do not have your level of skills and in-depth knowledge of the matters that we deal with.”

While useful in a skilled politician, embracing a diversity of views alongside communication to non-specialists is a toxic combination when managing monetary policy. It can only sow confusion. Arguably, attempts to shoehorn the diverse views of the Governing Council into a coherent single message has created both these blunders over the past year.

And these communication slips have brought additional governance concerns. 

It was in light of the “close the spreads” remark in March that Chief Economist and Board member Philip Lane began holding post-meeting private conference calls with market participants. His diary for March, released only in June, reveals teleconference calls with 11 investment banks and large asset managers on the day these remarks were made. Considering that the PEPP program was agreed by the Governing Council less than one week later, making these conversations inside what would normally be the quiet period for communication ahead of regular meetings, the danger that market sensitive information about Lane’s intentions might inadvertently slip into select private market participant’s hands was and remains very real. And while these meetings were eventually publicly disclosed, for those of us not privy to such conversations, even disclosure that they were happening at the time would have been useful. Better still, the meetings should be open to general participation and be recorded for posterity. It would also be useful, as an additional safeguard, if Lane were asked to guarantee that he won’t seek remuneration in any form from any of those privileged institutions once his tenure at the ECB ends.

It is these private communications that were made the subject of a recent question by a Dutch MEP, Derk Jan Eppink, to the European Parliament’s Committee on Economic and Monetary Affairs and to which the ECB responded last week. Lagarde’s response notes that “The ECB is continuously learning and reviewing its policies and practices with a view to making them as effective as possible – this is also true for the field of communication. To this end, the format of the calls [to market participants in private] you referred to is also being reconsidered.”

In her response, Lagarde also referenced the Code of Conduct for senior officials at the ECB in guiding these external communications. Yet when at the IMF it is well known, to those who witnessed such behaviour up close, that on Lagarde’s watch senior Fund officials regularly flouted staff rules. These rules are only “aspirational” if you dare to raise it with the Fund’s Ethics Office. And since Lagarde turned a blind eye at the Fund, will she be equally willing to accept breaches at the ECB?

In any case, while these private calls should indeed be discontinued and replaced by something more inclusive, doing so will not address the origins of the ECB’s communication challenge.

For the fundamental problem facing the ECB today is that governing by committee also requires determined and strong leadership, especially when communicating with markets. This was addressed explicitly by Alan Blinder in his Lionel Robbins Lectures at the LSE, Central Banking in Theory and Practice, when reflecting on his time on the FOMC. Consider the following passage from his first lecture:

“While serving on the FOMC, I was vividly reminded of a few things probably all of us know about committees: that they laboriously aggregate individual preferences; that they need to be led; that they tend to adopt compromise positions on difficult questions; and—perhaps because of all of the above—that the tend to be inertial… Inertial behaviour has its virtues, as I will explain shortly. But it also has some vices. In particular, decisionmaking by committee may contribute to the systematic policy errors I have mentioned already… 

While the Federal Open Market Committee has not been immune to this ailment over the years, there is at least one tradition at the Federal Reserve that tends to minimize it: that of the powerful chairman… no one has ever doubted that Alan Greenspan, or Paul Volcker, or Arthur Burns were ‘more equal’ than others… So, to a significant extent, FOMC decisions are his decisions, as tempered by the opinions of the other members. Nonetheless, a chairman who needs to build consensus may have to move more slowly than if he were acting alone.”

Contrast this with Lagarde’s own description of her style of policymaking quoted above, of seeking the views of Governing Council members for consideration before any decision is made. For Blinder, such consensus building in monetary policy decisionmaking is prone to errors. Can anybody doubt that Draghi was leading the Governing Council when making policy decisions between 2011 and 2019? Recall the backlash following his penultimate policy meeting in September 2019. Such is the price to pay for good policy.

What needs to be done now? The pressing problem is to clarify the size of the PEPP and the ECB’s willingness to use it. The FFC concept is too complicated to define and communicate. Drop it. Such a policy approach should be considered during the Strategy Review, of course. But for now, admit that the Executive Board was trying to be too cute and has in the process created confusion and uncertainty. Better to clarify that, although there is a diverse range of views on the Governing Council, based on the baseline judgement of the Executive Board, a PEPP envelope of EUR1,850 billion is necessary through March 2022. Of course, this can be recalibrated through the year as new information comes available. But on current plans it will be used in full. It is little commented that the Asset Purchase Program (APP) in 2020 fell short of its intended net purchases by about EUR30 billion (8 percent of target). As long as circumstances allow, PEPP could likewise fall short and it wouldn’t garner much attention. What matters is the determination to execute on policy and make sure markets are aware of it.

The more fundamental challenge is to wrest back control over policy from the consensus building approach. In its place the Executive Board needs to be more assertive over policy direction and to stop communicating with markets through side-channels. What the Governing Council should come to realise, if they haven’t already, is that it will be better for them in the long run to be overruled instead of pandered to. Indeed, the size of the PEPP program is probably larger than it otherwise needs to be just because of the “close the spreads” comment. In placing too much emphasis on the German Constitutional Court’s concerns, policy was badly impaired in March. Likewise, by excessively weighing the views of those for and against larger PEPP, we are left with confusion about the current policy stance. This has a fiscal cost, of course, and for the ECB a loss of credibility that can only be countered by a larger bazooka. In the end, everyone loses.

There are numerous opportunities to get communication back on track through scheduled speeches by Board members over the coming week. Let’s stop with policy experimentation, drop the compass and the anchor, and get back to the decisive policy needed to get through a global pandemic. The Strategy Review is the right place for thinking through new approaches. For now, stay focussed on PEPP and don’t be distracted by nonsense notions of financing conditions.


Argentina: How to blame the IMF

The original Argentina-IMF program agreed in 2018 with the Macri administration is coming under growing scrutiny as a replacement arrangement is being negotiated once more. Last week, legislators sent a letter to IMF Managing Director Georgieva to complain about the Fund’s involvement with Argentina, apparently broken into 31 different points

In particular, Senators are suggesting the Fund broke the Article VI of the IMF’s Articles of Agreement in the original program, under pressure from Macri via the Trump administration, and that as a result the Fund should accept responsibility for the failure—including by setting no conditionality in the program under negotiation.

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The balance of payments of the European Commission

THE EUROPEAN COMMISSION sits as non-resident to the euroarea in the convention of EU balance of payments (BOP) accounting, and has its own BOP published by Eurostat. Transactions between the euroarea and the Commission as part of the EU Budget or due to occasional EU borrowing operations, therefore, registers in their respective balance of payments. And this matters for forecasting the euroarea current account in the period ahead—a concept not yet grasped by either the IMF or, as today, the European Commission.

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A note on public debt sustainability under secular stagnation

A quick note on public debt sustainability in a world where i < g defined here as secular stagnation. There are a number of observations here relative to standard analysis when i > g.

For example, the primary balance does not depend on the bequeathed public debt stock at all, only on the future stock. So, there is no need to worry about stabilizing the backward-looking stock. Instead the focus should be the sustainable stock at some point in the unknown future when secular stagnation comes to an end.

In addition, it is possible to redefine public debt sustainability during secular stagnation as depending on the ratio of possible needed primary balance adjustment to the change in average interest rate on debt expected during normalisation.

I don’t have time to work on this properly, so if anyone wants to recycle this to influence the debate on fiscal policy, feel free.

Revised version posted 4th Nov 2020.

Don’t believe the WEO

ITS USEFUL to be reminded once again of the flaws that underpin the IMF’s World Economic Outlook (WEO) publication—as well as the fact that the Fund continues to fail to pursue her global multilateral surveillance responsibilities. Indeed, last week’s WEO provides yet more ammunition for those who claim the Fund peddles style and not substance, lacks an analytical basis for meeting her obligations.

But first the good news. This blog noted in a belligerent style how the April WEO assumed the global current account moved from a surplus “discrepancy” of USD375BN in 2019 to deficit of nearly USD375BN. The discrepancy itself is a puzzle that we need not solve here. But that doesn’t mean it can be assumed away. 

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Argentina in the WEO: Hold your nose and look away. Again.

YOU CAN change the mission chief, but you can’t stop the bullshit. That ought to be the IMF’s motto. 

While numerous crucial macro variables of concern for international investors have been purposefully suppressed in the IMF’s WEO database relating to Argentina, presumably to spare various blushes, there is enough there for us to smell the nonsense that the international monetary system—whatever that is—will be expected to swallow in the next 3 months as a new program is negotiated. 

Continue reading “Argentina in the WEO: Hold your nose and look away. Again.”

Argentina and the Fund: Time for a “Hail Mary” pass?

PDF version with annex.

It’s fair to say that the macroeconomic stabilization of Argentina, first during the Macri administration, including on the IMF’s watch, and now under President Fernandez, has failed. 

There have been many mistakes over many years on the way to this outcome—indeed, too many to recall here—as well as some bad luck. Rather than relive these mistakes, including the recent failure of the debt exchange to bring about macro-financial stabilization, we might ask instead what policy options are now available. What policies should the authorities and international community pursue to stabilize the Argentine economy in a time of COVID? 

In short: it’s time for a “Hail Mary” pass. And four features of the macroeconomic situation provide necessary background to this unlikely intervention.

Continue reading “Argentina and the Fund: Time for a “Hail Mary” pass?”