Key takeaways:
- Following the meeting of its Governing Council on June 4, the ECB announced an extension of its Pandemic Emergency Purchase Programme (PEPP) with an additional enveloppe of €600 billion over the initial €750 billion enveloppe – of which €234.7 billion has already been spent as of May 29, 2020 – bringing the total amount of the programme to €1,350 billion. The horizon of the purchases will be extended to at least the end of June 2021. The maturing principal payments from securities purchased under the PEPP will be reinvested until at least the end of 2022.
- In addition, net purchases under the asset purchase programme (APP) will continue at a monthly pace of €20 billion, together with the purchases under the additional €120 billion temporary envelope until the end of the year. All in all, at this stage, the total asset purchases made by the Eurosystem (ECB+ National Central Banks) to counter the coronavirus crisis is now expected to reach almost €1.5 trillion.
- The ECB and Eurosystem staff also published their quarterly macroeconomic projections. In the baseline scenario of the projections, annual real GDP is expected to fall by 8.7% in 2020 and to rebound by 5.2% in 2021 and by 3.3% in 2022. Compared with the March 2020 ECB staff macroeconomic projections, the outlook for real GDP growth has been revised substantially downwards by 9.5 percentage points in 2020 and revised upwards by 3.9percentage points in 2021 and 1.9 percentage points in 2022.
- While the projections remain in line with other forecasts made by the European Commission, the IMF and private professional forecasters, there is a high level of uncertainty surrounding these projections, as is illustrated by the presentation of three scenarios (baseline and two alternative scenarios) – instead of ranges derived from historical forecast errors
- The bleak outlook for inflation shows the profound deflationary forces at work. Judging from the experience of the last few years, we believe the ECB’s assessment of an uptick in core inflation by 2022 to be too optimistic. Should this be prove right, the asset purchase programme should last well beyond 2022.
Outstanding PEPP purchases at end-May 2020
Commentary on the ECB’s June 2020 quarterly Macroeconomic projections
The ECB projects a substantial worsening of the growth, inflation and fiscal outlooks for the Euro area in 2020 – in line with the projections of other institutions (European Commission, IMF), followed by a gradual improvement of the macroeconomic situation in 2021-2022. While the baseline scenario seems reasonable for 2020 – although the persistently high level of health and economic uncertainty makes it weakly reliable -, the projections for 2021-2022 might be qualified as crystal ball guesses in the current situation. This is acknowledged by the very broad range of the projections between the alternative best case and worst case scenarios beyond the baseline scenario.
Unprecedented level of macro uncertainty
The standard computation of the ranges (based on historical projection errors) would not, in the present circumstances, provide a reliable indication of the unprecedented uncertainty surrounding the current projections. Instead, in order to better illustrate the current uncertainty, alternative scenarios based on different assumptions regarding the future evolution of the COVID-19 pandemic and the associated containment measures.
2020 might well be remembered as an “outlier year” in terms of economic growth. But the risk of a sluggish recovery, or worse than that of a fall into a deflationary trap remains.
Bleak outlook for inflation
Comments by the ECB / Eurosystem staffs on their outlook for inflation reveal their deep concerns over the evolution of the macro situation given the broad-based impact of disinflationary effects and the tepid economic recovery.
Disinflationary effects are expected to be broad-based across the prices of services and goods, as consumer demand will remain weak due to income losses or hampered by government measures to contain the spread of the virus.
HICP energy inflation is expected to provide a large negative contribution to headline inflation in 2020.
Given the significant increase in economic slack and the indirect effects of the steep fall in oil prices, HICP inflation excluding energy and food is expected to moderate to 0.8% on average in 2020 and to pick up only towards the end of the projection horizon.
HICP inflation excluding energy and food is revised down notably over the whole projection horizon. It is dampened by the much larger than previously expected economic slack and, in the first part of the projection horizon, also by some downward indirect effects from the lower oil price assumptions.
Over the medium term, HICP inflation excluding energy and food is expected to pick up, with upward price pressures from rising demand expected to strengthen as the economic recovery progresses.
The later expectation might prove to be too optimistic considering that core inflation stayed around 1% over the last four years after an uptick in 2015. The APP initiated in 2015 did not manage to increase inflation which shows the limits of the ECB’s quantitative easing policy. ECB officials and some economists would argue that, were it not for this large asset purchase programme, the Euro area would have well fallen into a deflationary trap in the aftermath of the 2010-2012 sovereign debt crisis. However, it is not easy to draw robust conclusions on this issue (cf. this column authored by Adam Elbourne et al. in VoxEU) as counterfactual experiences are impossible to conduct in economics. The other area where the ECB’s APP programme did not reach its goal until very lately was the support it was meant to provide to real activity as is illustrated by the stagnation followed by lacklustre growth of loans to Non financial corporations and households over the 2010-2020 period. A subject we have already tackled a few weeks ago in our first discussion of the ECB’s response to the coronavirus pandemic.
Remark: the relationship between oil prices and HICP energy inflation is not straightforward as taxes on energy products are an important component of retail prices. In addition, energy efficiency policies implemented in the context of policies to fight climate change introduce an additional downward bias in energy intensity of gdp over the medium and long term.
Quantitative easing “fatigue” and the Lucas critique
Asset purchases by central banks create a ratchet effect or more plainly speaking a dependency that is akin to drug addiction. This has been documented in the literature over the last decade and this applies in the case of the Euro Area as we discussed in our earlier post. In the presence of new unexpected shocks the only answer henceforth is to double down on these quantitative easing policies (asset purchases, negative interest rates, ..) while acknowledging their reduced effectiveness. This diminished effectiveness in the long term is compounded by the famous “Lucas critique” of macroeconomic policy as economic agents adapt their expectations to the perceived effectiveness of economic policy, which eventually causes the underlying structural assumptions of the later to collapse.