Some people, including Jean-Claude Trichet's interviewer seem worried that the additional injection of outside money by the ECB will be inflationary. As I have argued previously, with respect to Fed policy, these fears are unwarranted.
To understand this, we'll need to review ECB policy institutions and recent developments on the ECB balance sheet. The ECB operates on a channel system, which has some similarities to the Canadian system. There is a marginal lending facility, for central bank overnight lending to financial institutions, and a deposit facility allowing for the holding of reserves. Current interest rates are 1.75% at the marginal lending facility, and 0.25% on the deposit facility, and these interest rates bound the overnight interbank lending rate. As well, there is additional lending through refinancing operations, at maturities of 1 week, 1 month, and 3 months. The current 1-week lending rate is 1% (see here for details).
Now, if we look at the most recent ECB balance sheet, note that, as in the US, the ECB is holding a large quantity of reserves, though not as much as a fraction of liabilities as the US. With a roughly 2 trillion Euro balance sheet, the ECB holds 282 billion Euros in its deposit facility. Consistent with this, in the May 2010 monthly bulletin, Chart 11, page 34, you can see that the overnight interbank rate is essentially being determined by the interest rate on the deposit facility (just as in the US).
Now, with a positive quantity of reserves in the financial system, and the overnight interest rate determined by the interest rate on reserves, purchases of government debt by the ECB are essentially irrelevant. The ECB is simply swapping reserves for government debt, and this will have little effect on anything, including the inflation rate. The only issue is the maturity mismatch on the ECB balance sheet - the ECB is borrowing short and lending long.
Now, in Trichet's interview, he seems a little confused about this. Like Ben Bernanke, he seems to think that he has to "lock up" the reserves in the deposit facility so that they will not escape and cause inflation. He says:
The additional liquidity that we are providing through the purchase of government bonds will be withdrawn again. Interest-bearing time deposits are an appropriate way to withdraw this liquidity.This is the same type of term-deposit facility that the Fed appears to be going ahead with. The idea is quite lame. When there is a positive quantity of reserves in the system, the central bank can control inflation by setting the interest rate on reserves. There is no need for a term-deposit facility - the central bank just has to pay more for the reserves this way.
Here is another point of confusion:
HB: Do you now start the same what the central banks in the United States and the United Kingdom have already been doing for a while?Trichet seems to think that he's different because of the term deposit facility. Baloney. Behind the smoke and mirrors, the ECB program is intended to subsidize Greece, just as the Fed's MBS purchases subsidize the housing market.
Trichet: That is not comparable. What the Federal Reserve and the Bank of England have done was “quantitative easing”. They were injecting liquidity into the markets and that with the explicit goal of augmenting the overall liquidity. As I said already what we are doing through the Securities Market Programme is not quantitative easing.