The European Central Bank has faced difficult decisions in recent years. It faces another one when its Governing Council meets on Thursday in Estonia.
The decision will be a close one, at least it should be. And, once again, the euro zone's central bank is likely to err on the side of significant prudence by avoiding any notable reduction in monetary stimulus -- even though the balance of arguments increasingly points to a different policy path.
The argument for some reduction in what has been significant and prolonged ECB stimulus is based on six realities:
- The euro zone is experiencing higher economic growth, with significantly less dispersion among its member countries.
- Forward-looking indicators point to further growth acceleration in the months ahead.
- Financial conditions overall have eased considerably, both in Europe and in the rest of the world.
- The risk of geopolitical shocks has diminished with the passing of the Dutch and, especially, French elections.
- The currency has strengthened against the U.S. dollar, raising the potential of growth headwinds down the road.
- There are growing political pressures to curtail the ECB's prolonged use of unconventional policies.
Yet the ECB seems in no rush to tighten monetary policy. Inflation is still too low for its liking and some officials there still remember the premature tightening of 2011. Then there are concerns about possibly destabilizing Italy in the run-up to elections there.
The mechanics of an ECB policy tightening at this stage are also complicated. Forward policy guidance has committed the central bank to substantial asset purchases of 60 billion euros ($68 billion) a month until the end of this year. Any change in this timetable could diminish the effectiveness of this policy tool in the future. But raising interest rates while maintaining such monthly purchases is analogous to driving a car while stepping on both the accelerator and brake pedals.
Facing these competing considerations, the ECB on Thursday will most likely revise upward its economic assessment but leave its policy stance unchanged -- that is, announce no reduction in its asset purchase program and no hike in interest rates. But it's a decision that will, and should, be hotly debated.
After all, you could have too much of a good thing, especially if one of the consequences would be to inadvertently reduce pressures on politicians to pursue the structural reform measures that many euro zone countries need if they are to sustain higher and more inclusive growth.
As such, the ECB would be well advised to signal, at the minimum, its intention that, at the September Governing Council meeting, it would be inclined to gradually move away from a policy stance that has bought the region important time but has not dealt, and cannot deal, with many of its growth impediments. These issues are solvable if politicians step up fully to their economic governance responsibilities.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Mohamed A. El-Erian is a Bloomberg View columnist. He is the chief economic adviser at Allianz SE, the parent company of Pimco, where he served as CEO and co-CIO. He was chairman of the president's Global Development Council, CEO and president of Harvard Management Company, managing director at Salomon Smith Barney and deputy director of the IMF. His books include "The Only Game in Town" and "When Markets Collide."
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