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European monetary policy

No change but an eventful day

Feb 7th 2013, 19:17 by P.W. London

EUROPEAN central banks were centre stage today as they announced their monetary-policy decisions for February. As expected neither the European Central Bank (ECB) nor the Bank of England (BOE) made any change to interest rates, which in both cases are at historic lows. But there were other important developments today. In Frankfurt the ECB seems to have given its tacit approval to Irish moves to restructure debt incurred in supporting its banks. And in London the BOE issued a rather gloomy statement about the economic outlook while Mark Carney, governor of the Bank of Canada, set out his stall in a way that suggests he will be more proactive in supporting the British economy when he takes over from Sir Mervyn King in July.

At his press conference Mario Draghi, the ECB boss, batted away questions about the steps taken this week by the Irish government to replace the promissory notes issued to support the collapsed Anglo Irish Bank (and a bust building society) with much longer-term debt. These measures, which will reduce the present value of the obligations, are politically as well as financially important to the Irish government as it tries to maintain public support for austerity (the €3.1 billion annual repayment due on the promissory notes was close to this year’s budget-tightening measures) while steering a path out of its bail-out programme by the end of this year. But they had to be acceptable to the ECB, since it sanctions the lending that the Irish central bank has in turn provided to Anglo Irish on the basis of these promissory notes. And the ECB has in the past resisted calls for a restructuring for fears that it might constitute monetary financing.

A deal of sorts appears nonetheless to have been struck though Mr Draghi was coy about what had happened. He confined himself to saying that the governing council had taken note of the Irish actions. But in a statement from Enda Kenny, the Irish prime minister himself noted: “Under the agreement reached today with the European Central Bank, the promissory notes are being exchanged for long term Irish government bonds with maturities of up to 40 years.”

The main policy question for Mr Draghi was whether the ECB should respond to the euro’s appreciation. Earlier in the week François Hollande, the French president, had complained that the strengthening of the single currency was hurting economies like France’s that had been trying to regain competitiveness. Mr Draghi was never going to respond to that provocation, but he left his options open. On the one hand he said that the appreciation of the euro was a sign of returning confidence and pointed out that the euro both in nominal and real terms was at long-run averages. But while stating that risks to the inflation outlook were broadly balanced he cited the appreciation of the euro as a downside risk. That leaves him and the ECB with room for manoeuvre if staff projections next month show that overall the risks on prices as well as activity are on the downside.

In London the BOE for its part surprised its watchers by issuing a statement, something it normally does only when it changes monetary policy. The central bank sounded a pessimistic note. Recovery would be slow while inflation was likely to rise further in the near term and could stay above the 2% target over the next two years. City economists were left scratching their heads as to why the bank had changed its communication strategy. Philip Shaw of Investec thought it might want to justify its stance ahead of forecasts revealing the inflation overshoot, which the BOE will publish on February 13th. Kevin Daly of Goldman Sachs thought it was likely to have been triggered by the imminent arrival of Mr Carney, who is keen on forward guidance.

Mr Carney’s appearance at a parliamentary committee had been eagerly expected for insights into how he might shake up the BOE and resuscitate a moribund economy. He seemed to have become less keen on the idea of targeting nominal GDP rather than inflation, an option that he aired last December for economies stuck in a rut. Instead he backed “flexible” inflation targeting, in particular over the time it takes to restore price stability, as well as “extraordinary forward guidance”. If Britain’s monetary-policy arrangements are altered this may be through making the bank’s mandate to meet the inflation target more explicitly flexible - though some might say that its record as a serial overshooter in recent years shows that it has had little difficulty in being flexible under the existing regime.

(from http://www.economist.com/blogs/freeexchange/2013/02/european-monetary-policy)

Questions on the contents of the article:

1. Which two important recent developments are described at the beginning of the article?

2. Which steps were taken by the Irish government to maintain public support for austerity?

3. What is Mr Draghi position as far as euro’s appreciation policy is concerned?

4. What announcement was made by the BOE and how did the City economists react to this?

5. What monetary policy was Mr Carney in favour of?

Say if the statements are true or false or no information is given on the subject mentioned:

1. As it was annonunced both the European Central Bank (ECB) and the Bank of England (BOE) made no change to the current interest rates, which are at their historic highs. (FALSE. The ratesare at historic lows)

2. The ECB seems to show an absolute disapproval and strong criticism of the Irish steps to restructure debt as a desperate measure for their struggling banking system. (FALSE. It shows its tacit approval)

3. Mark Carney is the governor of the bank of Canada and he is expected to take over from Sir Mervyn King in July. (TRUE)

4. Sir Mervyn King is the Chaiman of the Monetary Policy Committee. (NOT GIVEN)

5. The Irish government substituted the promissory notes aimed at rescuing the collapsed Anglo Irish Bank (and a bust building society) by much longer-term debt. (TRUE)

6. This step is a part of Irish budget-tightening policy and gives the government the ground to suspend its bailing out programme for the Anglo Irish Bank by the end of the year. (TRUE)

7. The Irish government as well as the Irish central bank are not dependant on the ECB, since the Irish central bank has a right to sanction the lending for Anglo Irish on the basis the promissory notes. (FALSE. The ECB has a right to sanction the lending for Anglo Irish)

8. According to Enda Kenny, the Irish prime minister, the promissory notes are being exchanged for long term Irish government bonds which are to be mature in 40 years’ time. (TRUE)

9. At the press conference discussed in the article Mario Draghi, the ECB boss was asked a question about whether the ECB is going to react to the increased rate of euro. (TRUE)

10. Mario Draghi stated that the euro both in nominal and real terms was at long-run highs. (FALSE. It was at long-run averages)

11. The British central bank made a surprisingly pessimistic statement about a slow economic recovery and the rising inflation rate that will stand at higher than 5% in the nearest two years. (FALSE. It will stand at higher than 2% in the nearest two years.)

12. The city economists found this announcement unexpected and explained this by either the BOE’s preparing the general public for the news of the extreme inflation acceleration or the coming arrival of Mark Carney focused on the progressive management policy. (TRUE)

13. The article discusses a parliamentary committee session with Mr Carney’s speculation about how to restore the fading British economy with backing “flexible” inflation targeting and “extraordinary forward guidance” as key measures. (TRUE)