ECB Should Use QE to Combat Deflation Risk, Says Eichengreen

The European Central Bank should fight the threat of deflation with U.S.-style bond purchases, said U.S economics professor Barry Eichengreen.

“The Europeans have a real deflation problem and the ECB is not on the case,” Eichengreen, a professor at the University of California, Berkeley, said in an interview in Wellington today. “I think they should do a version of quantitative easing that is tailored to European circumstances.”

ECB President Mario Draghi yesterday held the benchmark interest rate at a record-low 0.25 percent and said the bank is “ready and able to act” as it lowered its 2014 inflation forecast to 1.1 percent. The Frankfurt-based ECB aims to keep inflation just below 2 percent.

The euro-area year-on-year inflation rate was 0.7 percent in October, and Eichengreen noted that producer prices dropped 1.4 percent that month from a year earlier.

“That hasn’t fed through into the consumer price index yet,” he said. “It could feed through and bring that tepid inflation rate down still further.”

Eichengreen said the ECB should copy both the U.S. Federal Reserve and the Bank of England. It should follow the Fed in buying government bonds, while emulating the BoE’s program of encouraging banks to lend to small and medium-sized businesses.

“Inject the money into the banks, give the banks incentives to lend it,” he said. “That could make a difference. Some U.S.-style QE married with funding for lending.”

Most forecasters are too optimistic about Europe, Eichengreen said.

“The Europeans have put the acute financial crisis behind them, but they’re going to have more troubles next year,” he said. “They will have a political crisis in Greece, they are going to have more bumps along the road to banking union. So I think everybody is over-optimistic about Europe.”

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