Europe’s QE Quandary

The ECB's Options to Aid the Economy

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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. 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, and partly on concern about fueling asset bubbles. But now that the European Central Bank has exhausted most other options, it’s planning asset purchases and pressing ahead with other QE-like moves to get more cash into the economy.

The Situation

With Europe’s fragile recovery lagging the rest of the world and inflation running at a fraction of target, ECB President Mario Draghi has raised the prospect of large-scale asset purchases. On Sept.4, he said the bank would begin buying asset-backed securities along with covered bonds — a type of debt secured by a pool of assets, such as mortgages. The move came on top of an unprecedented round of measures unveiled June 5, when the ECB became the first major central bank to take one of its main interest rates below zero.  It then designed a lending program that ties the amount a bank can borrow to how much credit it extends to companies and households. The ECB will keep providing cheap funding to any bank that needs it in its regular operations — a sort of temporary, on-demand version of QE. Its plan to purchase bonds is hampered by the lack of viable markets for some asset classes, including those that bundle bank loans. The ECB has bought bonds before. It purchased sovereign debt from countries like Greece, Spain and Italy in 2010-2012, and covered bonds in 2009-2012.

The Background

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. 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. In comments that may mark a shift in stance, Bundesbank President Jens Weidmann said in March that QE would be permissible in certain circumstances.  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 quadrupled the size of the Fed’s balance sheet to more than $4.4 trillion.

The Argument

With deflation becoming a bigger concern in the euro area, chances for Fed-style QE in Europe are increasing, despite 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. If the ECB were to buy sovereign 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, and bond yields in countries like Spain and Italy are near record lows. 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 debt crisis in 2012 to do “whatever it takes“ to save the euro from collapse. That promise led to the untested Outright Monetary Transactions program, a government bond-buying plan that requires countries to agree to certain conditions. The program is being reviewed by the EU’s highest court after a German court said it may violate the law.

The Reference Shelf

  • 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.
  • Blog post on quantitative easing by Francesco Papadia, former director general for market operations at the ECB.
  • 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.

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