Friday, July 21, 2017

Is Federal Reserve and ECB Monetary Policy Coordination Practical?

Brad Setzer has an interesting post on central bank monetary coordination based on Lael Brainard's recent speech.  I am not convinced the issue is so much correcting "imbalances" or the supply of high quality government bonds in the eurozone.  If eurozone banks are keeping deposits at the ECB at a negative 40 basis points charge, what does that say about the balance sheets of those banks?  The ECB does not publish excess reserve data on a monthly or weekly basis; therefore, we have no timely means to track stock and flows.  Additionally, the ECB Asset Purchase Program is providing bank liquidity, but its operation has created excess liquidity in some surplus countries where the liquidity is less needed and regulatory balance sheet problems in other countries where banks need to hold on to
the high quality liquid assets they have. in a low volatility, very low interest rate environment which stresses bank profitability.  And if you have a lot of non-performing loans on your balance sheet, you do not need the additional stress of keeping (not selling) or buying (even a repo transaction in the eurozone requires the actual balance sheet transfer of collateral, even if a repo repurchase is in place) bonds.  In such an environment it is very difficult to make bond trading profitable as we have seen recently even in the largest US banks.

Setzer also cites another article in which is discussed the cross border imbalances in where the eurozone government bonds, despite country of origin, and being transacted and deposited.  Unfortunately, that article continues the false financial meme and economic fallacy of Target2 balances which I have written about on several occasions.  I find this disappointing from Setzer (who I respect), although the cited article does present an interesting discussion of bond transactions.  Unfortunately, the scenario of high yield Italian government bonds leading to a Target2 default is just bad economics.

While asset purchases and sells by central banks can have international effects, the economic situation will probably not be the same for each central bank.  It would be hard to coordinate except by one or more central bank lending market assistance to another central bank.  That scenario is potentially dangerous.  It would be something done to prevent worse choices.

It would be practical to coordinate currency exchanges, if the governments cooperate.  Central banks do not do fiscal policy.  The Federal Reserve has as one of its mandates employment, but the United States has a low growth employment and wage problem, which still concerns some Federal Reserve board members but cannot be resolved without fiscal policy from the government.  The US Congress has not done anything of value in improving employment or wages since the Great Financial Crisis.  In the eurozone there is no fiscal transfer process much less a fiscal union; it is a monetary union which means each eurozone country uses a foreign currency (euro) rather than have its own fiat currency.  If the ECB tries to control the euro exchange rate, it has different impacts on different countries, particularly if national central banks in some eurozone countries have low US Dollar currency reserves to lend banks in its countries to facilitate trades and liquidity.  Wages are stagnant in Germany and employment is at disastrous levels  and there is nothing being done to get people employed, economies growing, and workers having the ability to spend and save.

There are some things central banks cannot do if the fiscal governments do not cooperate.

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