Tag Archives: Quantitative Easing

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.

Weakened Euro

The Euro has been depreciating relative to almost all other currencies for a while now. The euro used to be able to buy ~1.40 American Dollars, but now has fallen to just 1.11 US Dollars. This has caused mixed opinions on whether this is a good thing for the Eurozone currently. This depreciating of the currency will bring many benefits to the members of the Eurozone and help get their economy, which has been struggling the most out of all major developed countries following the Great Recession of 2008. This will be done by the influx of demand for now cheap European goods. Consumers from all over the world will flock to the Eurozone as goods produced there have become much cheaper. A simple example of why consumers will flock to European goods is: imagine that France produces widgets. France’s widget costs 100 euros. As late as one year ago, this widget would have cost an American $140. This is because to buy a widget, an American must first exchange his American dollars for European euros. The exchange rate was ~1 euro=1.4 U.S dollars. Today though this same consumer can purchase this widget for only $111. This will cause a lot more consumers to demand these widgets and able to afford them! As Tommy Stubbington wrote in his Wall Street Journal article, Parity Rumblings Emerge Over Euro, “”The euro area stands to be a winner of the currency wars in 2015,” said Jonathan Baltora, inflation linked bonds fund manager at AXA Investment Management, which oversees 607 billion euros of assets, referring to the possibility that a weaker currency would make European goods cheaper than those produced in Japan and elsewhere.” This is precisely what is going to happen, and what Europe NEEDS to happen to finally get out of this period of virtually no economic growth lately. The European Central Bank knows this and that is why (or atleast part of the reason why) the ECB announced a quantitative easing plan of bond buybacks. As Joseph Adinolfi writes in his article, Euro Records Largest Weekly Loss Since Septemeber 2011, “BK Asset Management’s Boris Schlossberg rhetorically asked if eurozone quantitative easing was intended to drive the euro even lower, arguing that ECB Executive Board member Bernard Coeure admitted as much during an appearance from Davos, Switzerland that was broadcast on CNBC Friday. “Taken from that perspective the ECBs actions make perfect sense,” Schlossberg said in a Friday morning research note. “The QE announcement has shaved another 300 points off the EUR/USD exchange rate and the pair is now fully 20% lower than just nine months ago.”” This will hopefully give the entire Eurozone the economic boost it needs to get back on track as an economic heavyweight!

European Central Bank Stimulus Puts Pressure on Fed

This past Thursday, the European Central Bank announced a new quantitative easing program. The announcing of the program itself did not come as a surprise to many, as European officials have been hinting towards such a program since fall. However, the scale of the program was rather shocking as the dollar amount came in decently above expectations. The European Central Bank announced that their new round of quantitative easing will total one trillion Euros. The program will consist of buying bonds and other assets at a 60 billion Euro clip according to the Wall Street JournalThe article then goes on to explain the effects of such a large quantitative easing policy on currency exchange rates. When a country (or group of countries as in the ECB’s case) embarks in quantitative easing, their currency deflates. This alters the exchange rate between countries and decreases the value of the easing country. Therefore, exports from the easing country become cheaper to opposing nations.

Now if one country were to embark on a quantitative easing program, the deflationary effects would be clear. But as exchange rates change, other countries may be tempted to start their own quantitative easing programs so that their own exports may stay competitive. This competing of quantitative easing in order to manipulate exchange rates has become to be known as currency wars. The United States was a pioneer in quantitative easing after the Great Recession and embarked on three separate quantitative easing programs that sequentially increased in value. The United States is now uniquely positioned as the U.S. economy is booming while others such as Japan and the Eurozone are struggling and at risk of another recession. But will the U.S. be able to continue its recovery and strong economy while other nations continue to implement larger and larger quantitative easing programs?

Quantitative easing is not on the docket for the U.S. Federal Reserve anytime soon. However, raising short-term interest rates is. While quantitative easing causes a currency to look cheaper, raising interest rates makes it look more expensive. So while other nations are weakening their currencies, the United States will be strengthening theirs. This is the dilemma that the Fed is currently facing when trying to decide when to increase short-term interest rates. An article by Reuters discusses the challenges that the Fed faces, “But the increased stimulus measures from the ECB and elsewhere globally, including the Bank of Canada, may make it tougher for the Fed to move ahead with its own plan to start raising interest rates by mid-year, lest U.S. economic policy move out of sync with the rest of the world”. It is clearly important for the Fed to assess the monetary policy of other nations before setting their own. Due to the massive quantitative easing programs of some of the largest economies currently, I expect the Fed to hold off on raising the short-term interest rate until at lest the second half of 2015.

Greece Leaving the EU Would Not Help QE

The Eurozone has certainly been getting a lot of attention the past few days. Numerous economists are now speculating what will happen to the Eurozone after the ECB’s announcement to implement Quantitative Easing. Brian Blackstone of the Wall Street Journal says the European Central Bannk will purchase 50,000,000 euros worth of bonds each month to help boost the economy. Needless to say, many economists have little optimism given the numerous failed attempts to stimulate the European economy. My fear is the QE will not effectively help larger problems that can emerge from within Greece.

Greek Elections will be held this upcoming Sunday, and signs are pointing that the Syriza Party will now emerge as the governing body. According to Yannis Palaiologos of the Wall Street Journal, Syriza’s policies are very left-winged and will raise the minimum wage, cut taxes for the poor, and rebirth collective bargaining in the industrial sector. The larger fear, however, is that the leaders will soon find no point in remaining inside the Union. Palaiologos explains:

“…There are enough people in Syriza who support the logic of “resistance” against Brussels and Berlin to make such a coalition a realistic possibility. If Greece’s new government does decide to go down that road, the country might well exit the eurozone.”

The coalition here is unification with the Anti-EU Greek Communist Party. If these two parties merge, the impact could be detrimental on the Euro. The editors of Bloomberg View claim, “Investors may be driven to short the bonds of Italy, Portugal or Spain — no matter how strong the economic or political arguments against their leaving the currency union — driving their borrowing costs to levels they can’t afford.” This clearly is not what economists want to hear on the brink of a QE plan.

My reasoning for worrying about Greece is perhaps the same as most people. Over the past few years, Greece has been notorious for upsetting member states for their high government deficits, which end up being the bourdon of stronger nations, such as Germany.

To further this cycle, Germany is also opposed to QE. In the article “No More Excuses for Draghi,” the editors of Bloomberg explain how Germany sees, “…QE as a ruse by which the richer members of the currency bloc will end up paying for the fiscal misadventures of their neighbors.” If this were the case, then Germany would be even more disheartened if Greece left. Essentially, it would be a big punch in the face after trying to help someone up after they fell.

Although QE is certainly a step forward in fixing the euro crisis, there certainly needs to be more unification to make things work. Being part of the EU, member-states must understand the risks and costs associated with the pact, even though the Great Recession was not anticipated to deplete the economy as badly as it did. Together, they must reach an understanding of how to bring themselves out of the recession as one governing body. As a result, Greece needs to hold themselves accountable and remain in the union, while Germany has to support it’s fellow member state through thick and thin. By not moving forward on a unified front, the EU will surely continue to plummet.