Hardly a day goes by without Mario Draghi and his fellow ECB members receiving advice on what they should and should not do, or can and cannot do to revive the euro zone economy. Martin Wolf in Wednesday's FT once again waded into the debate. His piece was arguing for "radical cures for unusual economic ills". Mr Wolf begins the article explaining how an economic downturn, created by over leverage, is followed by a period of debt reduction and restructuring before the next recovery can begin. To facilitate this period of debt reduction central banks provide a loose monetary backdrop to work in. This is what the US have been doing, but just in greater measure than in previous downturns due to the size of the debt burden. The article becomes somewhat more involved, but the basic theme seems to endorse many of the measures so far put in place by the US in particular.
The article concludes that eurozone has so far not done much to encourage the saver to become a spender, which is what is required to reinvigorate the economy, and now needs to look to employ these radical measures.
If we understand his thesis correctly he argues that central banks can create demand by manipulation of asset prices, which again is what the US have been doing, and to some degree it has worked. As we have argued before the easiest asset to move is the equity market. Japan has tried for 20 years to reflate asset prices with limited success and have now resorted to the equity market. The Japanese government have announced that they are doubling their asset allocation to equities in their pension fund from 12% to 25%.
We discuss the barriers to the ECB buying government debt; the constant opposition from Germany seems to be the biggest hurdle. Despite this, Increased speculation that the ECB are prepared to introduce new measures has driven government bond yields in Europe to new lows. Spanish 10 year bonds now yield less than 2%, having approached 8% not so long ago.
Most economists seem to predict the same path for the eurozone as is currently being faced by Japan, and if reflating asset prices is the answer, surely the ECB should follow Japan’s lead and make it clear buying equities is a measure they will consider.
We have referred to the recent speculation that the ECB may consider buying corporate bonds, this is but a small step from buying equities directly. The state buying equities is often seen as a radical move to Mr Wolf’s point, but it’s not so radical as there are several instances of governments resorting to this measure in the past and it having the desired effect.