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By HaleStewart November 25, 2013 8:28 am
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European Central Bank Only Has Non-Traditional Measures Left

The European Central Bank is facing a very difficult policy environment: inflation that is too low and unemployment that is too high.  Consider the following two charts:

Inflation has been decreasing for the last two years, dropping from an annual rate of 3% at the end of 2011 to .7% in the latest reading.

At the same time, unemployment has been rising, although it appears to have peaked at a little over 12% over the last nine months.

The central bank has come close to exhausting traditional policy options.  Last July, Mario Draghi stated he would do “whatever it takes” to preserve the union.   Markets took this to mean the bank would engage in quantitative easing much like the US Federal Reserve.  This lead to rallies in the European equity markets and a modest euro rally relative to the dollar.   

But the ECB is coming close to exhausting traditional policy options.  Interest rates are already at low levels – especially after the latest cut – and there is only so much “jawboning” a central bank can do before it has to act.  In short, there are very few traditional policy options available for the ECB to use, thereby leaving the untraditional --  asset purchases and increasing the monetary base --  as the only viable options. 

Hale Stewart is a former bond broker who has been writing about economics and financial markets since 2006 on the Bonddad Blog.  He is also a tax attorney with a domestic and international practice while also forming and managing captive insurance companies for US companies.   You can follow him on twitter at:@captivelawyer

 

 

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