A cobweb in the Eurotower

Eurotower is the name of the building currently hosting the European Central Bank, waiting to move into its new premises later in the year, but it is not that the cleaning people in the Eurotower are not serious about their job: the cobweb I refer to in the title is the one presented in old microeconomic textbooks.

Three liquidity scenarios after the year-end.

There are 3 main scenarios that could develop in the liquidity and money market in the €-area at the beginning of 2014, after the tensions at the end of 2013.

First, tensions could dissipate since the reinforced year-end effect has gone.

€ liquidity is getting more valuable: what can be done about it?

It is a recurrent phenomenon that liquidity gets more valuable at the end of the year: this is seen in the fact that, notwithstanding the higher amount outstanding, the overnight money market rate (EONIA) increases in the last weeks of the year. While the phenomenon was suppressed during the crisis by the overabundant liquidity provision, before the crisis, the average increase between the beginning of December and the end of the year, was of the order of 36 basis points, concentrated in the last few days of the month (see table 1). 

…and what about the other side of the pond?

While on this side of the Atlantic the ECB was reacting more quickly than expected to the much weaker inflation prospects, I was in the US trying to better understand what is happening over there in the monetary area.

On the basis of the talks I had, I came back with a number of thoughts, which were not necessarily shared by my interlocutors but were stimulated by the discussions I had with them.

Forget the € and demand management!

The title of this post is a bit exaggerated, yet it helps stressing the gist of the point I want to make: policy makers, market participants and ordinary citizens should start devoting less attention to the € and to demand management and should concentrate, instead, on supply issues.

Let me expand a little this basic idea.

Don´t supply more when there is no demand!

Over the last few weeks the words uttered by the ECB President, first in front of the European Parliament and then in the latest press conference,  according to which the ECB is: "ready to use all available instruments, including a LTRO (longer-term refinancing operation), to ensure that developments in short-term money market rates are in line with our medium-term assessment of price stability." have attracted a lot of market attention.

Upward bias vs. downward bias: who will win?

ECB President Draghi confirmed, at the last press conference on September 5th, the unanimous view of the Governing Council: “we wanted to make it clear that we have a downward bias in interest rates for an extended period of time.“ He also said that “The Governing Council confirms that it expects the key ECB interest rates to remain at present or lower levels for an extended period of time. “

Target balances and the risk of another "Reparations" problem

The crisis that started in 2007, threatened the global economy with the demise of Lehman Brothers in the Autumn of 2008 and moved to Europe in the Spring of 2010, where it is still not surpassed, has shaken the trust of laymen and economists alike in the ability of economics to predict and manage events. The analogy with physics as a science and engineering as a technique has been found wanting.

Feydeau, Bernanke and Draghi

Georges Feydeau was a master in his theatre pieces to make actors enter and exit doors, as in a ballet, causing great laughter in the audience.

Also Bernanke and Draghi are busy with exits, albeit in opposite directions and causing much less laughter.

Bernanke started communicating to the market that it should not expect the FED to always ease further and that before too long it should slow down and eventually exit from adding to its portfolio of securities.