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ECB’s new policies to combat deflation, spur economy
June 6, 2014, 5:15 pm

Draghi says that the ECB is focused on raising inflation rates by increasing bank lending [Xinhua]

Draghi says that the ECB is focused on raising inflation rates by increasing bank lending [Xinhua]

The European Central Bank (ECB) has cut interest rates to just 0.1 per cent as forecast by economic analysts, and slashed current deposit rates to below zero at -0.1 per cent.

This would mean that banks that hold money overnight at the central bank would have to pay for the service.

ECB chief Mario Draghi said the unprecedented measures were necessary to help Europe avoid deflation, encourage banks to lend money to investors rather than park them in the central bank, and significantly pull countries out of persistent recession.

Recent data has the average inflation rate among the 18-nation eurozone at 0.5 per cent in the period up to the end of May 2014, and the ECB says that low inflation – or deflation – can postpone growth as consumers wait for bargain prices for goods and services.

Eventually, this leads to inadvertent stagnation.

The ECB has maintained that a two per cent inflation rate is ideal for eurozone growth.

Earlier, the International Monetary Fund said it was concerned that European economies were not moving out of recession quickly enough.

With investments increasing, the ECB hopes to lower the double-digit unemployment rate that exists in most eurozone countries.

Spain and Greece, for example, have unemployment rates in the 20 percentage zone.

When asked if the ECB would take further untraditional measures, Draghi said “Are we finished? The answer is no.”

Draghi’s approach indicates that the ECB is very likely to continue to intervene aggressively and proactively to avoid stagnation and prevent further strengthening of the euro.

The euro recently hit a three-year high against the US dollar, which ultimately hurt European exports to traditional markets.

While many analysts say the negative deposit rate is drastic, the ECB could still implement a stimulus programme, known as quantitative easing, as an additional measure if the European economy does not pick up.

In April, Draghi indicated that the ECB could consider launching such a programme.

“The Governing Council is unanimous in its commitment to using all unconventional instruments within its mandate in order to cope effectively with risks of a too-prolonged period of low inflation,” he said.

“There was a discussion of [Quantitative Easing] QE. It was not neglected in what was a rich and ample discussion,” he told reporters.

In a bid to increase liquidity (monetary supply) and promote lending – in particular when interest rates near rock-bottom levels but fail to revitalize the economy – Central Banks can resort to quantitative easing by flooding financial institutions with capital.

In 2009, the US Federal Reserve launched an $85-billion bond-buyback programme to generate stimulus in the economy following the sub-prime mortgage crisis which led the world into recession.

The Fed had stipulated that it would begin to phase out its programme – which also included keeping interest rates very low – only when unemployment fell below 7 per cent.

The Fed began tapering in $10-billion increments its stimulus programme when unemployment fell to 6.6 and 6.7 per cent in recent months.

Source: Agencies

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