ECB Quantitative Easing can’t save the Eurozone
Open Europe
In a new Briefing released ahead of the ECB's purchase of sovereign bonds to be launched later this week, Open Europe breaks down why quantitative easing by the ECB will have limited economic benefits at high legal and political cost.
QE: The remedy to the Eurozone’s woes?
It is now well-known that the European Central Bank will announce some form of Quantitative Easing (QE) at its meeting on Thursday. Those who have urged the ECB to launch QE as a means to kick-start demand and fight deflation in the Eurozone will no doubt celebrate – but the impact of QE on growth and inflation is likely to be limited. In a new Intelligence Briefing released this morning, Open Europe’s Raoul Ruparel, breaks down why QE by the ECB will not save the Eurozone – and why the political and legal costs of QE are high.
The Eurozone is dependent on bank lending
The ECB has already tried various meaning of injecting money into the Eurozone – and QE is merely another means to that end – though on a much larger scale. Bank lending will be the key avenue for QE to filter through to the Eurozone’s real economy, as non-financial corporations in the Eurozone get 85% of their funding from banks. However, banks are not passing on the level of liquidity needed to the real economy, and other forms of lending are not developed enough to make up the shortfall.
Different stage of the economic cycle
Many assume that QE in the Eurozone can have the same impact as it did in the US and the UK – but the Eurozone is in a different stage of its economic crisis. When QE was launched in the US and UK, their ten year borrowing costs were over 4% and 3.5% respectively. Currently that figures stands at 1.5% in the Eurozone. Mario Draghi’s famous promise that the ECB would do ‘whatever it takes to save the euro’ in 2012, saw borrowing costs across the Eurozone dropping, but this was not accompanied with better economic performance or inflation. There is little reason to think that QE will be any different. How much more can QE do?
Structure of the purchases
The purchase of government bonds will likely have to be split according the capital shares of the ECB – which means that almost half of the money injection will flow to Germany and France (26% and 20% respectively.) This means that even under a hypothetical €500 trillion purchase programme -which is emerging as the most likely figure – only a small percentage of the Eurozone’s sovereign debt market would be bought, and it would be much less than the purchases made under QE in the US and the UK.
The social and political costs of QE?
In addition to the limited economic impacts of QE, it will come at a high social and political cost, including:
Undermining German euro-support: Given the unpopularity of QE in Germany, there is a risk that political and public opinion in Germany will harden against the euro. This may leave Chancellor Angela Merkel with significantly less room for manoeuvre on issues such as bailouts in the future.
Free rider effect: Monetary action by the Central Bank in order to paint over deep economic and political fissures is unlikely to be long-term sustainable plan for the Eurozone.
Inevitable legal challenges: QE is guaranteed to be subject to a series of legal challenges, especially in Germany. Questions about the financial liabilities that will be created for the Bundesbank and German state without any democratic process are sure to ruffle feathers.
Sovereign bond purchases by the ECB will do little to help boost the real economy in the Eurozone. It may help buy some time, but this is not the fundamental problem at the moment. The ECB would prove much more effective to face up to the structural flaws in the Eurozone institutions and find a better way to encourage reform in exchange for fiscal transfers.
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