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Saturday, September 8, 2012

What is ECB's OMT?



To bail out counties such as Spain and Italy and to save the Euro Zone, ECB (European Central Bank) went ahead with its much-awaited bond buying programme better known as money printing or 'liquidity insertion ' leading into rising global markets.
Under this move ECB shall buy  short term bonds of one to three year maturity from crisis-hit countries to pump liquidity. A new economic term got originated – OMT (Outright Monetary Transactions), under which ECB shall continue its unlimited bond buying programme.
The ECB President Mario Draghi has justified OMT by calling it a necessary programme to save the Euro zone.
The beneficiaries of OMT shall necessarily have to implement austerity-measures to avail the same.
Simply put, austerity measures are nothing but the lowering of the government spending.
This is nothing but like an old wine in a new bottle.OMT was done fearing the threat of some members of the Euro zone deserting the common currency Euro.
The biggest problem with the debt-ridden countries is their inability to devalue the common currency Euro while they earlier would devalue their domestic currency to hive off their national debt to some extent.
As a result of the OMT, bond prices shall soar and consequently bond yields shall come down.
Euro-zone countries like Greece, Spain, Italy, Cyprus, Malta and Portugal are already under the clutch of the recession.
Money printing is often followed by the raging inflation as money supply in the system increases and to tame the same steps like sterilization are necessary.
The money required for buying bonds is electronic money with no backing like gold. As a sterilization move ECB shall increase the bank rate (the interest it pays to banks for parking money with it) so that excess liquidity is sucked out of the system so that inflation remains controlled.

Why ECB came out with OMT?

Borrowing costs in countries like Spain & Italy was rising for want of  liquidity. Under OMT, ECB will be injecting liquidity so that borrowing costs come down.
Higher borrowing costs hinder the GDP growth.

Why OMT is threatening in the long run?

First the unlimited bond buying of the government debt is spooking. OMT shall end when goals are achieved thus making it a spooking proposition. Sterilization only, is not enough but there should be a counter electronic entry (when economy stabilizes) to outdo the original electronic entry by which money was generated for the bond buying programme. But as per the history it rarely happens.
In USA too, after having done two rounds of the quantitative easing the third one is in the offing leaving no chance for the deletion of old electronic entries.

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