At last, the European Central Bank seems ready to inject some adrenalin into the moribund euro zone economy. After last week’s news conference, when European Central Bank President Mario Draghi strongly hinted that action would take place after the June 5 council meeting, there have been a host of interviews and leaks specifically describing the new ideas the bank has in mind.

The biggest measure, now almost a foregone conclusion, will be a cut in the interest rate the ECB pays on bank deposits from zero to negative 0.1 or 0.2 percent. Bank officials have also hinted at several additional stimulus measures: extension of loans to commercial banks at low fixed rates for three years or even five years; ECB purchases of bank loans to small and medium enterprises, packaged into asset-backed securities; and concessional lending to European banks on condition they pass on these funds to small and medium businesses.

The leaks generated a great deal of enthusiasm this week. The euro weakened from almost $1.40 to $1.37; bond yields in Italy and Spain fell to record lows; and European stock markets jumped 1 percent to 2 percent. Wednesday, the market reaction crossed the Atlantic, with interest rates on U.S. Treasury bonds falling to their lowest levels in six months.

Sadly, however, investors may be overexcited. Even assuming that all the reports about ECB plans turn out to be true, the bank failed to follow through on similar rumors several times recently. It is also far from clear that these policies would address the big economic problems facing the euro zone: feeble economic growth and widespread unemployment; a continuing credit crunch for small and medium enterprises in Southern Europe; vast imbalances in competitiveness between Germany and the rest of the euro zone, and deflationary pressures that create debt traps and balance-sheet recessions in the peripheral economies.

A negative interest rate on deposits, the measure that has been suggested most strongly, is unlikely to have much effect for two reasons.

First, banks that have excess cash to park at the ECB are, by definition, stronger, and most are located in Germany, France and Northern Europe. They do not need more incentives to lend to customers, since credit is readily available to businesses and households in Germany, Northern Europe and even France.

The credit crunch that needs to be relieved is in Italy, Spain and other peripheral countries — where banks are generally far weaker. Banks’ reluctance to lend to customers is due mainly to lack of capital, not an eagerness to hoard cash at the ECB.

If negative deposit rates eliminate the meager profits these institutions can earn by placing excess liquidity in the inter-bank market, their capital positions may, on balance, deteriorate rather than improve. And it is hard to see how this would boost their ability to lend.

Second, though negative interest rates may grab headlines, there is nothing magical about their economic impact. This has been demonstrated in Denmark, Sweden and Switzerland, where negative interest rates have been used in the past to discourage excessive capital inflows and to weaken currencies deemed too strong. In all these cases, the effects of imposing what amounts to a small tax on bank deposits turned out to be quite modest.

To achieve the desired results, negative rates had to be supplemented with other measures, such as foreign-exchange intervention or aggressive expansion of central balance sheets. All this amounted, in one way or another, to “printing money” and then using it to buy government bonds.

And printing money to buy government bonds, in the manner of U.S., British and Japanese quantitative easing, is the one kind of measure still ruled out for Europe by German opposition. Jens Weidmann, the Bundesbank president, just confirmed this. To be more precise, Weidmann has ruled out quantitative easing in Europe unless and until the other measures planned by the European Central Bank have been tried and found wanting.

The problem with the step-by-step approach favored by the ECB under pressure from the Bundesbank is that every step taken becomes an excuse for delaying the next step. Past experience suggests that ECB economists may well spend months “analyzing” and “studying” the consequences of negative deposit rates before they decide to move onto other measures, such as purchasing small and medium enterprise loans.

The ECB might even move faster than in the past and announce a package next month combining both negative interest rates and small- and medium-enterprise loan purchases. Yet this may not do much for Southern Europe without additional action to encourage investment and spending by businesses and consumers, as well as boosting the availability of credit by easing the regulatory pressure on under-capitalized banks.

What would really help these countries would be a relaxation of fiscal policies or a direct injection of government-backed credit into their small and medium businesses, along the lines of the government-backed mortgages that have transformed the British economy in the past year. Unfortunately, neither a fiscal easing nor any kind of government-backed credit expansion seems to be an option for Southern Europe, since both would directly conflict with the deficit-reduction programs and bank-restructuring regimes imposed on these countries by the European Commission and the ECB.

The upshot is that ECB action will probably prove just enough to prevent the euro zone economy from deteriorating any further, and the attainment of this stability will be offered as a reason not to do anything more ambitious — either with a monetary stimulus or by easing fiscal and regulatory constraints. A continuation of Japanese-style stagnation seems the most likely prospect for most of Europe, despite, or perhaps because of, the half-hearted action now expected from the ECB.



Anatole Kaletsky is an award-winning journalist and financial economist who has written since 1976 for The Economist, the Financial Times and The Times of London before joining Reuters.