Parsing Draghi's QE Gambit
Some questions and answers regarding the 1.14 trillion euros ($1.3 trillion) quantitative-easing program announced yesterday by European Central Bank President Mario Draghi:
QUESTION: Were the exuberant reactions of equity markets justified?
ANSWER: Yes. The ECB’s policy intervention is large and relatively open-ended. It reaffirms that the “asset channel” -- which involves lifting financial-asset prices to pursue broader macroeconomic objectives -- remains the main tool for central banks. And Draghi stressed the policy commitment by stating that the ECB stands ready to purchase bonds at negative yields.
Remember, this is a traditionally reluctant institution whose Governing Council had to strike tricky political compromises. In sum, the policy announcement was further confirmation that, by necessity rather than choice, central banks remain the markets’ best friend.
Q: What is the specific impact on markets?
A: It provides general support to risk assets, including equities and corporate bonds. It serves to repress interest rates overall, keeping them very low and limiting the differentials among countries (with the notable exception of Greece, where local political issues dictate market prospects, at least for the moment). And, importantly, it continues to push the euro lower, particularly against the dollar.
Q: Are economists as excited as markets?
A: No, and for understandable reasons.
Although the ECB has a good chance of meeting the intermediate targets related to significantly influencing asset prices, it may find it considerably more challenging to achieve the macroeconomic objectives of promoting high and sustainable growth while countering deflationary risks. Specifically, its policy tools are too partial and indirect to address the four big issues that haunt the euro zone economy: insufficient pro-growth structural reforms, unbalanced aggregate demand, pockets of excessive indebtedness and an incomplete regional economic union. So the best the ECB can do is to buy time in the hope that other policy-making entities with better instruments will step in, both at the national and regional levels.
Q: What about unintended consequences?
A: There will be both unintended consequences and collateral damage, though the ECB feels that these will be outweighed by the expected benefits.
I would keep a particularly close eye on foreign-exchange markets. Historically, large and rapid moves among the world’s major currencies – and, already, the euro has plummeted to its lowest level against the dollar in 11 years -- have tended to break things. We got a hint of this last week with the exit of Switzerland from its currency peg. Other central banks, from Denmark to India, have taken pre-emptive actions in an attempt to limit the spillover effects.
Q: So, longer-term, the jury is still out?
A: Yes. Moreover, the final verdict isn't in the hands of the ECB.
To remain part of the solution rather than becoming part of the problem, the central bank needs politicians to implement a host of national and regional policies. So far, there is little indication that this will occur any time soon.
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