Europe has struggled to rebound from the Great Recession. A few years ago, it appeared that the EU and the United States were recovering at roughly the same pace, as shown by this graph of World Bank data on GDP growth rates. In 2012, the EU dropped off of the path to recovery, posting a -0.4% growth rate, while the United States continued to chug on at around 2% growth per year. This divergence was largely a product of the two different policy approaches taken by the central banks of each economy. In the US, the Fed engaged in three separate rounds of large monthly bond purchases, or quantitative easing, with the goal of expanding the money supply and lowering interest rates. In contrast, the European Central Bank responded with the European Financial Stability Facility to provide liquidity to EU members, and several European states undertook austerity policies. It may be slightly naive to attribute all of the US economy’s recovery to QE, but it certainly appears to have been incredibly effective.
So why did the EU not even attempt QE while the Fed was rolling out several rounds of it? One big obstacle that the ECB faces is the fact that it is composed of a multitude of national central banks, making it far more difficult to coordinate asset purchases. However, it appears that the time may have finally come for the European Central Bank to enlist the help of QE. As reported in the Wall Street Journal, the ECB’s executive board has proposed a 12-month (at minimum) round of QE, composed of asset purchases of €50 billion per month. The bank’s governing body will meet Thursday to discuss the proposal. As noted by MIT professor Athanasios Orphanides in the Journal article, “the potentially open-ended nature of the program—the idea the ECB could continue beyond a year—is a bright spot that could give the program additional power”, since many economists believe one of the core strengths of QE is the effect on the market that expectations of aggressive future monetary policy can have. More specifically, a central bank indicating that it wishes to keep interest rates low will have far more credibility if it is engaging in QE, since it is exposing itself to the risk of losses on the assets it’s buying up if rates were to rise, as pointed out by an article in The Economist that gives a fantastic overview of the implications of QE.
As news of the potential ECB actions broke, the euro fell against the dollar – good news for the multitude of European states that rely heavily on exports to fuel their economy. Italian prime minister Matteo Renzi was one of those who welcomed the news, who claimed that he dreams of parity between the Euro and the Dollar in an interview with the Wall Street Journal earlier today, believing that it would grant Europe greater economic flexibility. However, it is not good news for everybody – German officials oppose the ECB plan, as noted in the first Journal article, since German taxpayers have concerns that they would be responsible for the more risky debt of other European countries.
Since I originally wrote this post, the official ECB press release has been issued, and thus some new pieces of information have emerged. The official plan is more ambitious than what was originally proposed by the ECB exec board: the monthly purchases will be €60 billion each, and will continue through September 2016 at minimum, far longer than the original 12 months. This would result in about a €1.1 ($1.24) trillion injection into the eurozone, making it about 75% the size of the Fed’s QE3 program (which was roughly $1.7 trillion), in a very similar format. The Germans are likely to be pleased with the loss-sharing arrangement: only 20% of asset purchases will be subject to risk-sharing, which, in my opinion, is a necessary arrangement to ensure that every member of the monetary union is convinced. It’s worth noting that the ECB is strictly targeting inflation with this policy, whereas the Fed’s primary goal with QE was to put downward pressure on interest rates. It is this disparity in policy goals that leaves me with doubts about how effective QE will be for the eurozone: interest rates are already quite low, so the ECB stands to gain little ground in that respect.