Has the 3-year LTRO Changed the Path Forward for the EZ Crisis?

There has been relative calm in the EZ crisis since December last year, when the ECB announced a three-year long term refinancing operation (LTRO) and a sharp widening of its collateral requirements.

Government bond yields fell in the periphery and debt issuance in January went remarkably well, particularly for Spain and Italy. Has the LTRO fundamentally changed the likely path forward in the EZ crisis?

The EZ crisis is a debt crisis, a fiscal crisis, a financial crisis and a political crisis, but above all else it is a growth crisis. The only way the LTRO could help to end this crisis is if it were to mitigate the contraction in GDP the EZ is facing or stimulate growth. As Rebecca Wilder (@newsneconomics) has explained in a recent blog post, the three year LTRO is one in a series of steps the ECB has taken to plug holes as deposits have fled from EZ banks and private repo funding markets have dried up.

The three-year LTRO has helped to relieve some of the pressure on EZ banks and has avoided the failure of a major European bank (along with the cascade of bank defaults that would follow). However, EZ banks are in a process of significant deleveraging—which undermines growth—and the three-year LTRO is unlikely to really change this. Some banks may use the ECB facility to accumulate assets like domestic sovereign debt. Arguably Italian banks in particular are so exposed to their own sovereign debt they might as well double down and use the LTRO to sop up more of it. For the most part banks are likely to continue to reduce their cross-border exposure though and will horde ECB liquidity as they prepare for the worst.

For more analysis on the three-year LTRO, see these pieces by myself and my RGE colleagues:

This post first appeared at Economist Meg.