Part of this article was first published in Warwick Economic Summit here.
The European Central Bank (ECB) finally switched off its money-printing machine, joining most of the world’s big central banks, such as the Federal Reserves and the Bank of England, in halting its crisis-era stimulus programmes. ECB’s President, Mario Draghi, announced last Thursday that it called time on its €2.6 trillion bond-buying scheme, commonly known as Quantitative Easing (QE).
The controversial monetary policy, QE, aims to boost spending and inflation by creating electronic money, then pumping it into the economy by purchasing assets such as government bonds. Essentially, Central Banks are bloating its balance sheet through a mass bond-buying scheme. The ECB embarked on this experiment back in 2015 amidst a seriously weak economy and the threat of corrosive deflation, hoping this tool will stave off any economic meltdowns.
To its credit, it worked – at least for most parts. The powerful presence of a €2.6 trillion stock of eurozone government bonds acted as a financial backstop, and when needed, was lent out as collateral in private-sector financial transactions. This encouraged investors to hold more riskier assets and eased constraints on borrowing. It also provided financing so that governments could run larger budget deficits to stimulate their economies. By effectively harnessing the power of QE, central banks successfully showed the world that it still had an answer to weak demand and low inflation.
But far from being Midas’s golden touch, the magical QE hit a snag in terms of achieving its goal of raising inflation rates in the eurozone. While November’s headline rate met the ECB’s target of 2 percent, the core rate of inflation – excluding volatile items such as energy and food – is stuck around 1 percent. It has been below 2 percent for the last 10 years. QE has done the job of stabilizing the eurozone economy during the crisis, but it is simply not able to prosper it. Thus, extending it would likely have a negligible impact on altering the eurozone’s current dismal growth path.
The move to end QE marked an important milestone for the eurozone, which will now be left to manage its economy using more traditional tools such as interest rate changes. And it will have to use these tools sooner rather than later.
The Eurozone growth has been unexpectedly weak throughout 2018. Worried ECB policymakers still maintain that the poor data is only a blip on the timescale, and that it should not divert their plans to halt expansionary QE. But when the European Purchasing Managers’ Index (PMI) – which ECB officials view as the best indicator of what will happen to growth – was released, the euro fell as much as 0.4 percent against the dollar on the day. In an hour from the results publication, the common currency was trading 0.3 percent lower at $1.1375.
In response to fears over a prolonged eurozone slowdown, and now that any extension of QE is ruled out by the ECB, what other alternatives are there to mitigate concerns over the dwindling health of the Eurozone economy? For that, Warwick Economic Summit turned to Fabian Zuleeg, Chief Economist and Chief Executive of the European Policy Centre, for his thoughts on the question.
“Whatever the current state of the Eurozone economy, monetary policy should not replace long term structural reforms that can address the underlying real economic challenges. So, support for innovation, cutting harmful subsidies, fiscal consolidation, labour market reforms, external economic policies etc. should lead to higher growth potential.
“QE was and probably still is necessary, albeit at a lower level, but it does not replace actions that can increase sustainable growth and jobs,” Zuleeg told WES in an email interview.
Zuleeg views that the long term strategy of the ECB should be to gradually reduce QE, and phase it out over time.
“However, this should be dependent on the overall economic situation, so the key question is whether the current weaker data is a blip or a longer-term trend. If the economy is weakening permanently, QE should be reduced at a lower rate than previously planned,” he added.
All central banks, including the Federal Reserve and the Bank of England, should not view extraordinary measures such as QE as a one-off tool, never to be used again. Inflation remains low and sluggish across much of the developed world, and the prospect of a downturn means they may be called into action again. With that in mind, let us keep Quantitative Easing in the shed for now, but never discard it to the waste pile.