After months of dithering while the euro-zone economy stumbled and inflation fell to perilously low levels, the European Central Bank has finally unleashed the few remaining weapons in its arsenal and promises to pursue more unconventional measures if necessary.
Even the more hawkish policy makers on the bank's governing council could no longer pretend that the 18-country monetary union was somehow immune to a Japan-style wave of crippling deflation and years of feeble economic performance.
The key to whether the extraordinary intervention will work lies as much in the realm of psychology as in economics. If the central bank makes a convincing case that it will do whatever it takes to combat deflation, businesses and consumers won't put off spending in the belief prices will fall. Especially when money is available at record low rates. That won't address the euro zone's fundamental structural woes, competitive imbalances or persistently high unemployment. But those lie way beyond the limited scope of monetary policy euro-style.
Rate cuts alone also won't accomplish much.
A widely expected reduction in the bank's key refinancing rate – to 0.15 per cent from a previous record low of 0.25 per cent – is not going to spark a surge of business investment or consumer borrowing. And a bolder move to take the deposit rate where it has never gone before at any major central bank – below zero to minus-0.1 per cent – seems unlikely to drive cautious banks to put considerably more capital to work in the weaker economies of the region.
True, the banks will now have to pay a penalty to leave their reserves in the ECB's vaults. But banks have been reducing the amounts parked at the central bank; and the effect on earnings of the negative deposit rate will be dwarfed by the boost from the lower refinancing rate.
Then there's the likelihood that the commercial banks will simply pass on higher costs to their customers. That's what happened when the Swiss and Danish central banks turned to negative interest rates. But by the time the National Bank of Denmark ended its experiment recently, it had done the job of helping to take some of the heat out of the krone.
Which is precisely what the ECB hopes will happen to the overvalued euro. A falling currency is the weapon of choice to keep persistent disinflation from morphing into outright deflation.
Still, ECB president Mario Draghi and his fellow policy makers realized that they had to do considerably more. And they have, setting up a program of up to €400-billion ($597-billion) in cheap four-year funding for banks that will be targeted at small businesses, which have been starved for capital since the financial crisis.
Mr. Draghi is also talking about outright purchases of asset-backed securities, and the bank is ending its policy of "sterilizing" its bond purchases by draining liquidity from the financial system.
The ECB has often been the most reluctant of central banks when it comes to deploying such tools. Even as it became plain that inflation was stuck in the slow lane, well below the bank's target of just below 2 per cent, policy makers kept insisting that the euro zone was not at risk of becoming caught in a deflationary death spiral that could do what the debt crisis didn't and tear apart the monetary union.
The central bank has finally changed its tune. The only question is whether it has acted in time.