It’s the new conventional wisdom: When all else fails to make economies grow, create new money and buy government bonds. That’s the formula dubbed quantitative easing, or QE. Most economists think it helped keep the U.S. and the other countries that used it — Japan and the U.K. — from tumbling into a catastrophic depression. Shouldn’t Europe try it, too? It’s difficult for the 18-nation euro area to do the same thing, partly because of European Union rules. But now that the European Central Bank has exhausted most other options, some form of QE is moving back to the center of attention.
With Europe’s fragile recovery lagging the rest of the world and interest rates near zero, the ECB is considering new remedies or the expansion of existing programs to get more cash into the economy. The bank still provides cheap loans to any bank that needs them, a sort of temporary, on-demand version of QE. Financial institutions have borrowed more than 1 trillion euros ($1.3 trillion) in three-year loans under the backstop. Outright bond-buying has played a part, too. Between 2009 and 2012, the ECB bought 77 billion euros of covered bonds, which are secured by a pool of assets, such as mortgages. It also bought bonds of debt-strapped countries like Greece, Spain and Italy from 2010 to 2012. That pumped out more euros, though the ECB also pulls them back with weekly money-market operations to neutralize the impact on the supply of money. It’s now looking at halting that drain in the system, turning the program into a kind of retroactive QE. The bank is also considering buying other types of securities to rekindle credit flows. It’s hampered by the lack of viable markets in Europe for some asset-backed securities, including those that bundle bank loans.
The treaties that founded the modern EU prohibit the ECB from financing governments. Germany’s Bundesbank, whose iron grip on prices after World War II helped to soothe German memories of 1920s hyperinflation, has been particularly outspoken against printing money, and its presidents have criticized the ECB’s ventures into the gray areas. Their argument: Besides risking inflation, the moves reduce the incentives for governments to stop overspending and make their economies more competitive. For the Germans, it’s a matter of principle, even though deflation, or a fall in prices, now seems to be a bigger threat than inflation. So far, the scale of the ECB’s stimulus measures is small. Government bond purchases never exceeded 9 percent of the bank’s balance sheet, and all the stimulus added up to less than half of total assets in 2012. In the U.S., by contrast, bond purchases of $3.6 trillion swelled the Fed’s balance sheet to a record $4.15 trillion.
Unless significant deflation risks appear in the euro area, Fed-style QE isn’t very likely in Europe, for reasons both practical and political. Financial markets are much less liquid than those in the U.S., and the interest rate countries pay on their bonds varies widely across the bloc. If the ECB were to buy bonds proportionate to the size of its member countries, more than half would come from nations like Germany and France, where yields are already low. Targeting peripheral countries could undermine efforts to make them rein in spending. There’s also still a debate about the effectiveness of QE and concern that it fuels asset bubbles as the money flows into stocks and other assets instead of benefiting companies and households. Still, ECB President Mario Draghi pledged in 2012 to do “whatever it takes“ to save the euro from collapse and he has more tools in his arsenal. They include the untested Outright Monetary Transactions program, a government bond-buying plan that was unveiled at the height of the debt crisis. To quality for purchases, countries would need to agree to certain conditions. That program is being reviewed by the EU’s highest court after a German court said it may violate the law.
The Reference Shelf
- Blog post on quantitative easing by Francesco Papadia, former director general for market operations at the ECB.
- Speech by ECB Executive Board member Benoit Coeure on the OMT bond-purchase program, one year after its announcement.
- Research paper from the Federal Reserve Bank of St. Louis comparing QE policies of the world’s four major central banks.
- ECB working paper analyzing international spillovers of QE in the U.S.
- QuickTake on negative interest rates.