Should Europe Utilize Quantitative Easing?

Quantitative easing is a measure taken by a central bank purchasing government securities in order to increase an economy’s money supply and, therefore, lower interest rates.

Aside from Greece, every country in the Eurozone’s long-term interest rates have fallen from their January 2014 rates. Some countries’ rates have fallen almost 2 and three-quarters of a percent, the average fallen amount among Eurozone countries (excluding Greece) being 1.77%. As many countries’ interest rates approach zero, quantitative easing fails to be as effective or even possible.

Governing Council member of the European Central Bank Jens Weidmann announced Thursday that the ECB will not be taking part in any quantitative easing strategies in the immediate future. The ECB would consider quantitative easing to remedy recent declines in inflation rates. However, Weidmann explained that these levels indicate disinflationary trends rather than deflationary trends. He attributes recent disinflationary trends with the falling costs of energy, which are temporary.

This comes after ECB executive board member Peter Praet explained that the ECB had “an obligation to act” to ensure it meets its remit of near 2% annual inflation for the region, he said.” Praet does not believe that inflation is caused by fluctuating energy prices.

Stephen Williamson, Vice President of the St. Louis Fed, argues that quantitative easing not only does not help disinflationary trends, it is deflationary in nature. His argument is as follows:

“when the Fed engages in quantitative easing it acquires securities held by investors in exchange for dollars. Investors will only accept those dollars, according to Williamson, if they believe the dollars will rise in value. Which is to say, the operation of QE seems to imply deflation.”

Senior Editor for CNBC John Carney argues that term premiums have much more to do with it. Investors will accept these dollars if term premium—the added return of holding long-term bonds over cash—shrinks. He believes that quantitative easing leads to shrinking term premiums and therefore it is a self-starting cycle that does not cause deflation.

I think Europe should not engage in quantitative easing until the deflationary period that Weidmann discussed ends. The risk of acting too quickly and not allowing other effects to take place would be hasty. The ECB should wait and see what will happen with energy prices and the cost of oil. Also, the ECB should observe Greece’s recovery and see if the Greece’s government will stick to the measures that have been placed on them and how that will affect the broader economy.

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