The broken monetary policy transmission mechanism in euro area27 July, 2012, 15:55. Posted by Zarathustra
Tags: Euro Crisis
Yesterday, Mario Draghi said in a conference in London that the ECB will do whatever it takes within its mandate to preserve euro.
He also said essentially that if “the size of these sovereign premia hampers the functioning of the monetary policy transmission channel”, and that is within ECB’s mandate.
This probably hints a possible resumption of the securities markets programme (SMP), or bond buying. Maybe.
As Mario Draghi said in previous Q&A session of press conference following ECB governing council meeting (3 May 2012):
Draghi: As you may remember, the SMP was created to address malfunctioning or non-functioning in the channels of transmission of monetary policy. To this extent the instrument is still there, but, as I have said many times, it is neither eternal nor infinite in its application.
The chart from Goldman Sachs’ this week’s European Economics Analyst below shows just how the monetary policy transmission mechanism is “broken”. Core countries, particularly Germany, have their retail lending rates significantly lower than the periphery.
Source: Goldman Sachs
From Goldman Sachs:
In normal times—when financial markets are unified and functioning properly—ECB rate decisions exercise close control over banks’ refinancing costs in the money markets throughout the Euro area. And, albeit with lags of varying length, refinancing costs are passed on by banks to their borrowers: in the end, interest rates on loans and mortgages follow the policy rate in a uniform way across countries.
But, in the context of the ongoing crisis, financial markets have become dysfunctional. This has led to an impairment of monetary policy transmission in general, and of the traditional interest rate channel (described above) in particular. Reflecting this, in a recent speech Banque de France Governor Noyer noted that July’s ECB rate cut had been passed through to borrowers unevenly across Euro area countries: sovereign tensions had segmented the money market, leading to different financing conditions in different jurisdictions.