When the ECB statement hit on Thursday, it took about 45 seconds for market participants to realize that the forward guidance around rates and renewed asset purchases essentially equates to “QE Infinity” – a promise of perpetual central bank buying contingent only upon the achievement of a goal that has so far proven elusive.
Until the inflation outlook “robustly converges to a level sufficiently close to, but below, 2%”, rates will be as low as they are now, or lower, and QE will continue.
The capital key will be a constraint eventually, but there’s considerable runway between now and the time when the ECB would be forced to alter that.
Among the criticisms lobbed Draghi’s way on finance-focused portals and social media, was the notion that there’s something inconsistent about calling for fiscal policy to take the reins, while promising to buy assets in perpetuity.
In its strongest form, the argument is that central banks should force politicians to take fiscal action (i.e., spend to help engineer robust growth and reinvigorate the reflation story) by refraining from further monetary largesse.
That kind of critique makes for amusing tweets, but that’s about it.
Central banks have a mandate and as Bill Dudley wrote in his infamous Op-Ed about Trump, under normal circumstances, central banks respond to what’s going on without concerning themselves with what “message” it might send. He specifically addressed the issue noted above. “The Fed, for example, wouldn’t hold back on interest-rate cuts to compel Congress to provide fiscal stimulus instead”, he wrote.
In other words, this isn’t a staring contest or a game of chicken between central banks and politicians. It’s not advisable for monetary policymakers to sit on their hands in the face of calamity and dare politicians not to loosen the purse strings. Call central bankers “out of touch” if you like, but as a group, politicians have proven to be even more so, which means if you dare them to screw up, they almost assuredly will.
But beyond that, BofA’s Barnaby Martin notes that one “overlooked” aspect of QE is the way in which it “‘transforms’ sovereign debt-to-GDP ratios by moving bonds from risk-averse investors towards more risk-tolerant central banks”.
“If QE is sizable enough, the transformation in debt-to-GDP ratios can be meaningful”, Martin wrote, in a Friday note.
Those two visuals illustrate the dynamic. In the left pane is Italy’s debt-to-GDP ratio, and as you can see by the blue-shaded area, the ratio ex-CB holdings began to decline in 2015.
“Japan, of course, is a much more meaningful example of this”, Martin goes on to write, adding that “the BoJ’s holdings of Japanese government bonds now represent 85% of GDP [while] Japan’s debt-to-GDP ratio, excluding central banks, has fallen from 180% to 110% since 2011”.
How does this encourage fiscal policy? Well, the answer to that is obvious. Here’s Martin to explain:
Why is this risk transfer important? It may help ease the transition from monetary policy to fiscal policy. After all, fixed-income markets are less likely to be subject to tantrums as debt levels rise, if the long-term buyers of sovereign debt are (risk tolerant) central banks. Note that Japan has one of the highest government debt-GDP ratios across the globe, and yet the volatility of JGBs has been conspicuously low since 2010.
This is yet another one of those times where critics will invariably assert that this is all a Jenga tower and that, eventually, even a soft wind will collapse the house of cards. Keen observers will also point out that fixed income markets are actually more fragile and more prone to tantrums in the post-crisis world (see the 2015 bund tantrum, for example) thanks in part to central banks’ commandeering of markets, with Japan being the poster child.
Be that as it may, it’s hard to argue the other side of this. That is, does anyone really want to suggest that the best way to motivate politicians to embark on fiscal stimulus is for central banks to send a message that they will never buy more assets and may actually become active sellers of the debt that’s currently sequestered on their balance sheets? Of course not. That would be a ridiculous thing to say. No sane government that understands how QE works would want to chance issuing debt to fund stimulus into a market where the central bank was an active seller and price discovery was suddenly allowed to come roaring back to life after laying dormant for years upon years.
Indeed, the ultimate manifestation of new era stimulus (MMT) requires close coordination between fiscal and monetary policy, something Stephanie Kelton will be more than happy to tell you all about. Additionally, Martin describes central banks as “buy-and-hold”, which pretty much by definition means these asset purchases are arm’s length deficit financing, one step removed from MMT. (He doesn’t say that, nor does he advocate for it, we’re just doing some common sense extrapolating.)
“Thursday’s ECB meeting was all about the need for fiscal policy to take over”, BofA’s Martin goes on to say. “In this light, Draghi’s ‘QE Infinity’ may be an important stepping stone in the right direction”.
Maybe this is why bonds sold off so sharply into the weekend.