The European Central Bank should adopt quantitative easing now rather than as a
last resort
Aug 2nd 2014
ALONE among its peers, the European Central Bank (ECB) has resisted
quantitative easing (QE). That policy creating money to buy financial assets
has been used at varying times by the central banks of America, Britain and
Japan to fight deflation and stimulate economies flattened by the financial
crisis of 2008. Yet the ECB still shuns QE, treating it as a weapon of last
resort, even though the euro zone is suffering from lowflation , with prices
rising by just 0.5% in May and June, far below the bank s target of almost 2%.
Is it right or wrong to forgo a policy that has become standard practice
elsewhere?
One reason to doubt the efficacy of QE in the euro area is that banks rather
than markets dominate the provision of credit there. In America, in contrast,
companies raise much of their funding in the bond markets. One of the main ways
that QE has boosted the American economy is by lowering corporate borrowing
costs. As the Federal Reserve bought Treasuries and government-guaranteed
mortgage securities, pushing down their yields, investors turned to corporate
bonds, in turn driving down their yields. This effect would necessarily be
feebler in the euro zone.
This suggests that the ECB should work through the banks in fighting
lowflation. It is striving to do that in two main ways. In June it brought its
main lending rate down to a new low of just 0.15% and became the first big
central bank to introduce negative interest rates, which in effect charge banks
that leave deposits with the ECB. This has helped lower money-market rates in
the euro zone almost to zero and cap the appreciation of the euro, which was
contributing to disinflationary pressures.
As well as this general stimulus to the euro zone, the ECB is also seeking to
galvanise the recovery in southern Europe, where small firms in particular
remain starved of credit. Mimicking a policy invented by the Bank of England
the funding-for-lending scheme the ECB will make funds available at dirt-cheap
rates to banks until 2018 as long as they do better in lending to the private
sector (excluding household mortgages).
The new funding operations, starting in September, will take time to work their
way through to the economy, but the ECB is prepared to be patient. It has
always insisted on a long horizon for meeting its inflation target. It points
to inflation expectations, gauged both through the financial markets and the
views of professional forecasters. These suggest that inflation, despite its
recent lows, will eventually return to the target of just under 2% and thus
remains anchored .
Even if these forecasts are correct, however, the euro zone stands out among
big economies for the depth and likely duration of its bout of low inflation.
Lowflation is already hurting debtors in the euro area since their incomes are
rising more slowly than they expected when they borrowed. Their plight would
intensify if lowflation mutated to deflation. The real burden of debt rises
when prices are falling. That effect would be especially pernicious in the euro
area as levels of private and public debt are perilously high in many
countries.
Moreover, the risk of deflation is greater than the ECB acknowledges. Deflation
crept up on Japan in the 1990s even though inflation expectations remained
positive. The ECB draws comfort from the consensus among forecasters that
inflation will return to the target in five years time, but that view is more
a vote of confidence in the ECB than a reading of the economic tea leaves.
Inflation expectations over shorter horizons, as inferred from financial
markets, have been falling. Consistent with this, broad money has been growing
this year by only about 1%, which supports the case for QE to inject more money
into the economy.
There is nothing to prevent the ECB from pursuing QE as well as its funding
operations to promote higher lending to the real economy. Britain also relies
more on its banks than does America, but that did not dissuade the Bank of
England from deploying QE between 2009 and 2012. Moreover, it also launched the
funding-for-lending scheme while it was still carrying out QE.
The ECB would be a late adopter of QE, but this in itself is an advantage, in
that the policy has already been road-tested by more adventurous central banks.
Early foreboding that QE would debase the currency and cause a debilitating
inflationary surge has been discredited.
Paroled sovereigns
The real reason for the ECB s allergy to QE lies in its unique status as a
supranational central bank setting monetary policy for countries that retain
fiscal sovereignty. Private-asset markets in the euro zone are not big enough
for purchases to have much impact so, like the other big central banks, it
would have to buy lots of government debt. But unlike its peers, it would be
buying the debt of 18 different countries, in amounts linked to the respective
sizes of their economies. These purchases would have a much bigger impact in
peripheral Europe, where credit ratings are poor, than in Germany, which
retains AAA status. The Bundesbank in particular fears that QE would relieve
the pressure on less creditworthy countries to overhaul their economies and to
keep deficits in check. And it would mutualise within the ECB the risk of
holding dodgy sovereign debt.
These risks are real, reflecting the dash for a premature monetary union before
the right fiscal and political conditions were in place. But the ECB already
crossed the Rubicon in 2012 when it promised, if necessary, to buy unlimited
amounts of the bonds of euro-zone governments under attack by investors. That
guarantee saved the euro from the fury of the markets. However, a slide down a
debt-deflation spiral could also create an existential crisis. In these
circumstances patience is imprudent: the ECB should get a move on.
From the print edition: Finance and economics