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But in late 2008 these ratios were abruptly and drastically increased. Just as banks were tripping up over  bad debts, the International Monetary Fund and the Bank for International Settlements — backed by the G20 group of nations — decided to kneecap them. They were told that in future they must operate with capital/asset ratios more than 50 per cent higher than before. This double shock stopped banks from increasing their loans to the private sector. In the decades leading up to the Great Recession such lending had been the key force in bank-balance-sheet expansion, the main driver of the benign increase of 7.5 per cent a year in the quantity of money. (When a bank extends a new loan, it adds identical sums to both sides of its balance sheet. The new loan is an asset which should in due course be repaid; the new liability is a deposit, which is part of the quantity of money since it can be used to make transactions.) 

Quite apart from the Grexit pantomime, the plunge in the growth of credit and money was so severe that by mid-2011 the eurozone faced an existential crisis. Mario Draghi, the current president of the European Central Bank, assumed the job on  November 1, 2011. As an Italian himself, Draghi was more alert than his north European colleagues to the impact of the crisis on output and employment. He realised that radical steps had to be taken to ease the pressures on the most vulnerable banks in the weakest countries. Within a few weeks of his appointment he announced what became known as “the Draghi bazooka”, a huge programme of long-term, low-cost loans from the ECB to any bank in the eurozone that might want the money.

Here was the first of two vital crutches for the eurozone cripple. Banks were given more time to meet official demands for higher capital ratios, and by 2014 the mood of emergency and fears of financial disintegration had gone. But the Draghi bazooka enabled banks only to fund their existing levels of business. It did prevent too sharp declines in loans and deposits, but it did not spark renewed growth in banks’ asset portfolios or the quantity of money. In April 2014 Draghi began to argue the case for large-scale ECB asset purchases, citing the success of comparable schemes already implemented under the “quantitative easing” label in the US and the UK. An increase in money growth might not fully restore the happy conditions in the first period of the eurozone’s existence, from 1999 to 2008, but it would improve demand and output, and counter the vicious deflationary processes in Greece, Cyprus and elsewhere.

The ECB started buying assets on an immense scale in early 2015. For a time these purchases ran at a rate of €80 billion a month, equivalent at an annual rate to almost €1 trillion. When a central bank buys assets from non-bank companies and financial institutions, the effect is to boost the bank deposits held by the companies and financial institutions selling the assets. In other words, the effect is to increase the rate of growth of the quantity of money. The ECB asset purchases — the second crutch for the crippled eurozone’s banking system and economy — explain why money growth revived to a 5 per cent annual rate in the third and latest period of the single currency’s existence. Consistent with Friedman’s claims about the importance of money to economic activity, the higher rate of money growth has been accompanied by above-trend growth of demand and output, and rising employment. The asset purchases (eurozone QE, in effect) seem to have revitalised the patient. Instead of hobbling around on its last legs, the single currency area has started to walk. It recorded good economic growth, with output up by 1.8 per cent in 2016 and 2.3 per cent in 2017, fully matching the performance of the United States.
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untenured
July 9th, 2018
11:07 AM
"our analysis will have a deeply worrying message for those who believe — as Europe’s single currency approaches its 20th birthday — that its future is secure." It is secure because it is one of the essential constituents of the Average Empire, which is the proper description of the EU, whatever it pays its PR to say. All the EU has achieved in its short history is the ruination of its statelets, with its ceaseless determination to lay down regulations which, it is told, will make it ever more popular.

Anonymous
July 4th, 2018
9:07 AM
Whoever replaces Sr. Draghi, they just need an enigmatic smile and the ability to watch the ballooning ECB balance sheet expand relentlessly. A cryptic statement from time to time, will keep the economist community happy as they obsess over QE and ignore ZIRP.

Anonymous
June 29th, 2018
9:06 AM
Sr. Draghi's only responsibility is to take in any delinquent loan denominated in €, put it in the safe with all the others and hand the bearer a brand new shiny ECB version in exchange. It means that when, let's say Germany, comes along to be paid out, they will be invited to root around in the safe and find something that's worth more than the paper it's written on. Fat chance.

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