The ECB has pulled the trigger, but will the bazooka blow?

Jan. 25: The first weekend playbook, and the big question this week: now that the eurozone has committed to quantitative easing, will it work?


In the rush to get the economic headlines of the day, it can be hard to get a sense of what a development really means. The weekend Morning Playbook is an attempt to go a little deeper into the debate over the issues or events in the news this week. 

It’s the ear-grinding phrase that was everywhere this past week: quantitative easing. But a boring word hides a lot of big questions: even if the European Central Bank has committed to the “bazooka” (as journalists are fond of calling it), will the program really offer a magic bullet for the eurozone economy?

First, a recap: on Thursday, the ECB announced they would begin a program of quantitative easing, otherwise known as when a government “prints” money (a.k.a., they create the money electronically), and uses the new “cash” to purchase massive amounts of assets, mainly government bonds. As the demand for those bonds increases, prices rise, and interest rates fall – which, ideally, creates a ripple effect that means banks are more willing to lend, and borrowing is cheaper for everyone.

QE, for short, is considered an unconventional form of monetary stimulus for when interest rates can’t go any lower, and lending simply isn’t picking up. The program has had a high profile in recent years: the U.S., the U.K. and Japan have all used bond-buying to stimulate their economies, with mixed results. The announcement has long been anticipated, and many noted it had been priced into the market already, so the surprise this week was not the program itself but its size. ECB president Mario Draghi announced a €1 trillion euro program – €60 billion a month – a larger dose of stimulus than expected.

The announcement of QE seems to have an immediate effect – bond yields dropped, and the euro dropped to an 11 year low. But now the “will they or won’t they?” speculation is over, there are plenty of questions about how effective the program will actually be.

It seems everyone has an opinion on this – and the main issues are the differences between the eurozone economy and the U.S. and U.K. economies, political division over how the risks should be shared, and reservations about whether QE is a band-aid to patch over badly-needed structural reforms.

One of the main issues is that QE is intended to push bond yields lower – but in many parts of the eurozone, bond yields can’t get much lower, partly because of the “Draghi Put”, Mario Draghi’s confidence-building assurance that he would do whatever it takes to maintain the euro.

Another factor is one of “too little too late”: when the Fed started QE in the U.S., the American economy was stronger – inflation was at 1.6 per cent (with a two per cent target), whereas December numbers for the eurozone show prices are already falling, by 0.2 per cent. The ending date for QE is either September 2016, or when inflation hits the two per cent target – and that’s a pretty big jump.

To do that, the program has to encourage lending – and the worry here is that if the banks aren’t lending now, another drop in yields, especially if it’s only a small drop, might not make the difference in pushing credit down the pipeline to the average borrower.

There’s been a lot of political division within the eurozone over the use of QE, particularly from Germany: the German central bank’s president has probably been the loudest critic, particularly of creating a program where risk is taken equally by every country. This isn’t surprising – Germany’s bank is both known for being particularly conservative, and the German economy is much stronger, and therefore less risky, than Spain or Italy. The decision by the ECB to limit “risk sharing” on QE debt is both a break from tradition and a result of this opposition.

The move means that central banks will buy debt on behalf of the ECB, and bear the responsibility for any restructuring or defaults as a result of the program. It’s a compromise, and there’s criticism (including from the IMF) that this could dent the credibility of the program: after all, the eurozone is supposed to act as one.

The other, time-old criticism is that the eurozone’s problems are structural, especially in terms of the strength of exports and the labour market, and QE alone simply won’t fix those problems. Part of the point of QE is to push the euro down and therefore spur exports, but countries still have to compete in other ways to make their products attractive around the world. Despite their QE program, the U.K., for example, continues to import far more than it exports.

All of these worries come down to one kicker: QE is usually a last resort, and there aren’t really any other weapons left in a central bank’s arsenal if it doesn’t work. In fact, theoretically, it could end up making existing problems much worse.

It’s a doom-and-gloom note to end on, but in the wake of the announcement, there’s a lot of optimism, too: the ECB promised to break out the big guns for the sake of the euro. They needed to put the money where their mouth is, and Draghi and the ECB have followed up on that promise.

Ultimately, the real argument for QE is the hope that that promise leads to confidence, and that confidence proves contagious, getting banks lending again, and Europeans spending.

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