ECB credit boost for SMEs?

Draghi said at a conference in Sintra, Portugal, that an inability to get credit was hurting viable companies in countries such as Spain and Portugal and holding back regional growth.

He said the ECB could make more cheap credit available to banks, to encourage them to make new loans to borrowers in turn. Or, the ECB could purchase securities based on loans to small companies, an indirect way of making money available which would take the risks of borrower defaults off the balance sheet of commercial banks and onto the ECB's balance sheet.

The central bank's balance sheet, unlike that of commercial banks, is not subject to bankruptcy rules.

Draghi said that such measures "could help reduce the drag on the recovery coming from temporary credit supply constraints."

The ECB is widely expected to take some form of action at its next policy meeting on June 5, but Draghi would not specify what the bank was likely to do.

Many economists think the bank will cut its benchmark interest rate from what is already a record low of 0.25 percent. That would marginally reduce the cost of credit when banks borrow from the ECB, in hopes they would pass such lower rates on.

The ECB could also impose a negative interest rate on money that banks deposit with it, pushing them to lend instead of hoard it.

Not a cure-all

However, it is unclear whether credit supply is the main problem holding back business investment. It could instead be credit demand.

It's not clear why businesses operating in an environment of mass unemployment and consequent low consumer demand, at a time when most people have little money to spend, should be interested in hiring more employees or investing in new projects.

Making the cost of borrowing marginally cheaper to businesses, when interest rates are already extremely low, does very little to stoke credit demand.

The eurozone faces a slow recovery, with growth of just 0.2 percent in the first quarter, and high unemployment of 11.8 percent. Nearly all of that growth has been in the already prosperous northern countries like Germany.

The economies of most southern countries continued to shrink in 2013, although some showed signs of having hit bottom in early 2014.

A more drastic but far less likely step for the ECB would be to start buying bonds and other securities in secondary bond markets, to increase the amount of circulating money in the financial economy, and help lower market interest rates. The U.S. Federal Reserve (the US central bank) has done this with some success.

ECB purchases of government bonds from secondary markets would flood institutional investor' portfolios with money, which they would have to reinvest. This flood of money would tend to drive up the prices of other financial investment assets, such as corporate stocks - as has happened in the USA.

The Federal Reserve has engaged in sustained massive purchases of bonds from secondary markets, often termed "quantitative easing" or QE, to the tune of about $80 billion per month for the past two years.

QE also tends to increase the inflation rate. This is not necessarily undesirable. There are concerns that a eurozone low inflation rate of 0.7 percent, well below the ECB's target inflation rate of just under 2 percent, could become ingrained for a long time.

Low inflation makes it harder for countries and companies that have piled up too much debt to work off those burdens; that's why low inflation may be appealing to creditors, but harmful to debtors. Draghi said the ECB was "not resigned" to the current low level of inflation.

The wealth effect

The main purported benefit of QE, according to its proponents, is that increases in asset prices (such as pumped-up stock prices) results in a "wealth effect" - i.e. some people or corporates who hold stocks that gain in price would sell them to take profits, and then spend that money into the real economy, on consumption or investment goods, thus stimulating demand and boosting GDP.

However, economists who have studied the empirical data suggest that the "wealth effect" on GDP is very small. Some suggest that a far better way to stimulate aggregate demand would be for the ECB to purchase newly issued bonds directly from a government infrastructure fund, thereby creating new money for new projects and new jobs directly.

They point out that this would also be much more socially fair than artificially pumping up stock prices, which benefits only those who are already wealthy enough to have substantial stock-holdings.

But ECB purchases of newly issued bonds from government agencies are illegal under the 1992 Maastricht Treaty on European Union, which established the basic terms of reference for the ECB.

The restriction was imposed out of a fear that governments might over-spend and cause high inflation if the central bank were allowed to directly finance governments.