Europe’s QE Quandary

Why the ECB is Finally Buying Bonds

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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. Could it work in Europe, too? It’s difficult for the 19-nation euro area to do the same thing, partly because of different interpretations of European Union rules, and partly because of concern it could undermine efforts to push governments to do more to revive their economies. But now that the European Central Bank has exhausted most other options, it’s  pressing ahead with full-blown QE.

The Situation

The central bank began buying government bonds on March 9, six years after the U.S. embarked on QE. Europe’s fragile recovery is lagging the rest of the world and a drop in prices is threatening to make things worse. President Mario Draghi overcame German-led opposition on the bank’s Governing Council and pledged an asset-purchase program worth about 1.1 trillion euros ($1.3 trillion). The ECB finally turned to bond buying after cutting one of its main interest rates below zero last year, the first major central bank to ever try such a move.  The stimulus plan sent the euro tumbling to its lowest level against the dollar in a decade and pushed yields on some government bonds into negative territory. The ECB is also still providing cheap funding to any bank that needs it in its regular operations — a sort of temporary, on-demand version of QE. It began buying covered bonds in October — a type of debt secured by a pool of loans, such as mortgages — and added asset-backed securities in November. Despite the controversy, asset purchases aren’t new to the ECB. It bought sovereign debt from countries like Greece, Spain and Italy in 2010-2012, and covered bonds in 2009-2012.

Source: ECB data
Source: ECB data

The Background

The treaties that founded the modern EU prohibit the ECB from financing governments and broad buying of government bonds tests that idea. 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 expanding the supply of money. The argument: 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, is now a bigger threat than inflation. Before Draghi suggested in September that the ECB could add as much as 1 trillion euros to its balance sheet, the scale of its stimulus measures had been small. Government bond purchases never exceeded 9 percent of total assets, and all the stimulus added up to less than half of them in 2012. In the U.S., by contrast, bond purchases that ended in October quadrupled the Fed’s balance sheet to more than $4.5 trillion.

The Argument

Fed-style QE in Europe will need to overcome both practical and political challenges. Companies get most of their funding from bank loans rather than selling bonds, which is more common in the U.S. That makes European financial markets smaller and much less liquid. Government funding costs also vary widely across the bloc. The ECB will buy sovereign bonds proportionate to the size of its member countries, so the bulk will come from nations like Germany and France, where yields have fallen below zero. The plan might include the purchase of bonds from debt-strapped countries, raising concern it could end up bailing out profligate, reform-weary governments. 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, Draghi pledged at the height of the euro zone’s debt crisis in 2012 to do “whatever it takes“ to save the common currency from collapse. That promise led the bank to design a bond-buying plan to rescue the currency that it never tested, the Outright Monetary Transactions program. That arrangement is still being reviewed by the EU’s highest court, suggesting the challenges to bond-buying in Europe won’t go away.

The Reference Shelf

  • ECB statement from March 4, 2015 laying out details for its bond-buying program.
  • blog by Francesco Papadia, former director general for market operations at the ECB.
  • QuickTakes on negative interest ratescurrency wars and the euro crisis.
  • Draghi’s speech from April, 2014 outlining possible policy responses and a speech by ECB Executive Board member Benoit Coeure from September, 2013 on the OMT bond-purchase program.
  • 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.

First Published Feb. 25, 2014

To contact the writer of this QuickTake:

Jana Randow in Frankfurt at jrandow@bloomberg.net

To contact the editor responsible for this QuickTake:

Leah Harrison Singer at lharrison@bloomberg.net