2015-12-15 12:11:47
The treatment is helping but the patient remains weak
Dec 12th 2015
THE year started with the belated adoption by the European Central Bank of quantitative easing (QE) creating money to buy bonds in the euro area. As the year ends, QE, which loosens monetary policy even when there is little scope to cut interest rates further, is being extended by an extra six months, so that the purchases will last until March 2017. Does this mean that the ECB s monetary medicine is proving less effective than expected?
Mario Draghi, president of the ECB, argues on the contrary that the adoption of QE has been crucial in fostering the recovery in the euro area. QE has driven down long-term interest rates, the bank reckons, just as it did in America and Britain. Like their counterparts in those countries, ECB staff have analysed the effect of announcements about QE on the markets. Their study found that both the prospect of QE in the autumn of 2014 and the formal embrace of it in 2015 the policy was adopted in January and started in March was responsible for half of the percentage-point fall in the average yield of ten-year government bonds in the euro zone between the start of September 2014 and the end of March 2015. The contribution to declines in countries such as Italy, which had been assailed by the bond markets, was even bigger, at 0.7 percentage points (see chart).
In America, where markets rather than banks dominate finance, such a reduction would in itself provide a direct stimulus, as the fall in government yields spreads to corporate bonds and mortgage finance. In contrast, banks are the main providers of finance in the euro area. However, QE appears to have indirectly eased credit conditions. In particular it helped to reduce lending rates in the stressed economies of southern Europe. These had stayed stubbornly high long after the acute phase of the euro crisis ended in the autumn of 2012. The ECB s study argues that by improving the economic outlook, QE lowered credit risk for banks, enabling them to cut their loan rates.
Another way in which QE has supported the euro-zone economy is by pushing the euro down. That helps exporters, as well as boosting inflation by making imported products more expensive. The ECB s study estimates that QE was in itself responsible for a 12% fall in the euro against the dollar. In fact the euro has dropped by even more than that. It is currently trading around 20% lower than in the spring of 2014. Another ECB policy the imposition of negative interest rates, which started in June 2014 provides a possible explanation for the extra weakening. The ECB lowered its deposit rate still further this month, to -0.3%.
QE has proved its worth in other economies, so it is hardly surprising that it seems to be working in the euro area too. Yet the pace of recovery, though stronger than before, remains disappointing. Euro-zone GDP is still below the level it reached in early 2008, before the financial and euro crises; America s GDP surpassed its previous peak during 2011. Headline inflation is barely above zero. Core inflation, which excludes volatile items like food and energy, is close to 1%, well below the ECB s goal of nearly 2%. All this suggests the ECB may have to prescribe yet more QE next year.