German judges versus the ECB

The German Federal Constitutional Court (Bundesverfassungsgericht) made a decision concerning the ECB’s QE program1.

This article explains how the ECB can defend itself.

But I want to play devil’s advocate, and defend the German judges.

Despite buying thousands of billions of euros worth of bonds, the ECB has undershot its inflation target for years. The Court has a point that buying vast amounts of sovereign debt doesn’t seem proportional to this disappointing outcome.

In fact, the ECB could achieve its primary objective of price stability with a much smaller balance sheet. For example by dual interest rates. Or by helicopter money.

Second, the Court could prohibit the Bundesbank from participating in QE. But buying German bonds was not needed for monetary policy anyway! It was a political decision to buy bonds proportional to the national capital key in the ECB.

Finally, the decision of the Court should force European politicians to fix this mess. Maybe the ECB should have a dual mandate like the Fed has, so inflation and employment carry the same weight in monetary policy decisions. Or they could change the structure of the Eurosystem. Do we still need 19 national central banks when we have the ECB? Sounds like a make-work scheme to me…

Interlocking balance sheets and the corona-induced sudden stop

This post highlights the financial problems caused by (the reaction to) the coronavirus. I look at the balance sheets and cash flows of five sectors. The five sectors are (1) businesses that continue operations, (2) businesses that are closed due to the coronavirus, (3) households, (4) the government and (5) banks.

Key findings:

  • Businesses face a cash crunch
  • The net worth of households falls by about 50% of GDP due to lower stock prices
  • Each month of lockdown costs about 2% of annual GDP
  • The accrual of fixed costs while revenue is down is the fundamental problem of the corona crisis
  • Loans and tax deferrals can prevent bankruptcies for a while
  • However, loans and tax deferrals don’t protect businesses and households against insolvency
  • Therefore, the government should transfer resources to those hit by the crisis
  • Fiscal consolidation after the health crisis is over imperils the recovery
Continue reading “Interlocking balance sheets and the corona-induced sudden stop”

How the ECB can stop the coronavirus crisis overnight

I haven’t posted on the blog in a while, but I’m very active on Twitter.

Here’s my 3 point plan for the ECB:

(1) The ECB should issue bonds, which are risk free (the ECB cannot default on euro liabilities). It should buy every sovereign bond trading at a yield of 40 basis points or more above the yield on the ECB bonds.

(2) The ECB should set the interest rate on TLTROs at -5% until six months after the coronavirus public health crisis is over.

(3) The ECB should do helicopter money as soon as businesses are operational again, because the outlook for price stability is bleak.

This is not a drill

The ECB, government leaders and the banking sector must act immediately to stop the financial panic caused by the coronavirus.

A recession can still be avoided.

Banks should provide bridge loans to businesses suffering from the corona shock.

The ECB should do a TLTRO-like operation, providing cheap funding proportional to banks’ SME/corporate credit portfolios. Make the terms of the ECB loans conditional on coronavirus metrics. For example: banks should repay 4 months after the last new COVID-19 case is detected in the EU.

If Europe’s leaders fail to act decisively, the financial costs will snowball.

The economics of the coronavirus on Twitter

The coronavirus won’t cause a recession

But the reaction of policymakers might.

The direct impact of the coronavirus on the economy is limited. Unlike disasters such as hurricanes or earthquakes, there is no material damage. Few workers have been incapacitated by the virus.

Once the spread of the virus is under control, the economy can recover quickly.

The greatest risk is that politicians and central bankers will let financial uncertainty get out of hand. The stock market has taken a hit. Some companies will need to defer payments.

Continue reading “The coronavirus won’t cause a recession”

Cross border financial services: Europe’s Cinderella?

The Belgian Financial Forum and SUERF held a colloqium about cross border financial services in Europe.

An impressive line-up of speakers from the public and private sector discussed why European banks don’t sell more services outside their home countries.

Some pointed out that regulation is still fragmented along national borders – despite the banking union.

But the recurring theme of the day was the lack of profitability. There is no business case for mergers and acquisitions. Countries like Germany and Italy have way too many banks.

Chart by Morgan Stanley, via Johannes Borgen

The industry would be better off with fewer players, but nobody wants to take over small banks with wafer-thin margins.

You can read my Twitter thread about the event here.

The slides of the presentations are available here.

AI lawsuits are coming

AI will disrupt finance, but not in the way some tech bros think.

In a viral thread, David Heinemeier Hansson describes how Apple Card discriminates against his wife. Nobody at the company can explain how the algorithm makes its decision. Just “computer says no”.

That’s the kind of bureaucratic horror you expect from an old-fashioned state-run company. Ironically, Apple markets its credit card as “built on the principles of simplicity, transparency, and privacy” and “Created by Apple, not a bank”.

Yeah, I’ll stick to my bank, thanks.

If you can’t explain your AI, lawsuits are coming.

Long lawyers, short black box AI.