Approches

Ⓓ The European Central Bank should support the economy and citizens more directly

Reader's digest

• The ECB does not interact directly with citizens, it uses the financial system as an intermediary to transmit its policies.
• It does this by lending money to banks and other financial institutions who then, in turn, lend to non-financial businesses and households — or the real economy.
• The ECB does therefore not control the activity of commercial banks nor determine who gets loans — although it does have certain instruments that encourage lending to households and businesses such as TLTROs.
• Other instruments are further removed from citizens, such as the ECB’s quantitative easing programmes.
• Despite its numerous measures, the ECB is not meeting its price stability target of close to but below 2%, which begs the question of whether its’ existing tools are really fit for purpose
• One proposal would be for the ECB to bypass the financial system as its intermediary, and engage more directly with citizens, households and governments.

Full explanation

We have all seen the headlines this year: the European Central Bank (ECB) is producing vast amounts of money to curb the effects of the Covid-19 crisis on the European economy. But where does all this money go? Why is it not being used to finance local businesses that are going bankrupt, or to help people keep their jobs? We are living in a world with rising inequalities, where bankers seem to be the winners and ordinary citizens the losers. Where does the work of the ECB fit in?

Today, the ECB operates indirectly with citizens through the intermediary of the financial system. In other words, the ECB relies primarily on private banks and other financial institutions to “transmit” its policies, by lending to these institutions. Financial institutions, in turn, lend money to non-financial businesses and households (also known as the real economy). However, today, the ECB only weakly controls private sector bank activity by setting a key interest rate, and not by determining who gets loans.

One reason for this decentralized approach is that the ECB is not ideally positioned to assess whether someone or some business should get a loan or not. Commercial private banks who have branches in local towns and cities are better suited for the job, as they are better able to assess the risk of lending to certain customers and to the local economy.

To encourage banks to lend to the economy, today the ECB lends money to commercial banks at negative interest rate! 

An example of this is the  ECB’s Target Longer Term Refinancing Operations (TLTROs). Last year, banks borrowed more than 1.7 trillion euros through the ECB’s TLTROs, for a rate of -0.5% or even -1% under certain conditions. 

Negative interest rates are a double edged sword. On the one hand, negative rates are supposed to allow banks to lend money almost free of charge to companies and citizens. But on the other hand, negative interest also represent a penalty fee for banks on any reserve money that commercial banks leave in their deposit account at the ECB. This penalty is supposed to encourage private banks to do whatever they can to avoid leaving money sitting idle in the ECB’s accounts, by lending this money to the economy where they can at least earn interest on it. But in practice, banks also tend to pass over the cost of the negative rates onto their customers.

Negative rates and the TLTRO lending programme come on top of the 2.800 billion euros that the ECB has already pumped into the economy since 2015 through its quantitative easing (QE) programmes. For the most part, this money, instead of going to new investments in infrastructure, local businesses and jobs, is pumped into financial markets or real estate. It enriches the owners of these assets, which in turn increases wealth inequality, and has very little positive impact on real economic activities.

Despite these massive interventions, the ECB has not achieved its primary mandate of ensuring a price stability target of close to but below 2% for the last 7 years.

It follows from this that the ECB’s existing instruments seem unfit for purpose. In theory, reducing interest rates on bank loans and public debt should allow and encourage people, companies and governments to invest more. However, in practice, the ECB cannot force people to take more loans if they do not want to, which is often the case as some people are already over-indebted or are worried about future economic prospects. 

Some economists argue that the ECB is not using the right tools to achieve its mandate. Instead of relying on intermediary private commercial banks to create more loans, the ECB should directly inject money into the economy. There are several ways the ECB could do that, ranging from cancelling debt to distributing money directly to people or to governments to encourage public spending.

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Start the debate

The ECB’s approach of depending on financial intermediaries such as private commercial banks to lend to the economy has failed. The ECB is not using the right tools, and it is time to try a more direct approach.  Instead of relying on intermediary banks to create more loans, the ECB might as well directly inject the money into the economy for example by distributing money directly to people, governments, or by cancelling debt.

Want to dig even deeper in this debate? Click on any of the links to discover concrete ideas for the future of the ECB, or join the debate and contribute your own ideas.

→ #6 The European Central Bank could distribute money directly to people

→ #7 Introduce a digital euro and allow every citizen to hold central bank money

→ #8 Change European Union Treaties to allow for direct financing of government spending

→ #12 Forgive Covid-19-related debt of people and businesses