European Affairs


The European Central Bank finally launched (January 22) an unprecedented government-bond buying program – headlined as “quantitative easing” – to pull the European Union back from the precipice of deflation and stimulate economic growth.

The widely expected package calls for national central banks to buy their own country’s government bonds and thereby protect all Europeans from having to cover the loan defaults of profligate member-countries. ECB would, in turn, buy €60 billion ($69 billion) monthly in government bonds from the central banks starting in March. These purchases would continue until at least September 2016, or “until we see a sustained adjustment in the path of inflation which is consistent with our aim of achieving inflation rates below, but close to, 2 percent,” ECB President Mario Draghi said. ECB sovereign debt purchases would never exceed more than one-third of a country’s total debt issuance (the ECB holding of each type of bond would be capped at 25 percent). No corporate bonds would be included. Also, interest rates for four-year loans to banks were lowered by 0.10 percentage point, but other ECB borrowing rates were remained the same.

Draghi forged this structure to appease Germany’s concerns against mutualizing – or spreading out – the risks of sovereign defaults. The ECB decision was backed by “a large majority of the ECB’s governing council], so large we didn’t need to take a vote,” he said.

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Source: Economist, “QE in the euro zone.” January 21, 2015.

spellman012215 2Source: Claire Jones, “European Central Bank unleashes quantitative easing.” Financial Times, January 22, 2015.

No special restrictions were placed on Greece, but Draghi noted that to qualify, Athens must adhere to the bailout program being administered by the troika (the International Monetary Fund, the European Commission, and the ECB). The country’s central bank has already sought an emergency line of credit (“emergency liquidity assistance”) as a precaution should four major banks face massive withdrawals following victory of the populist, leftist Syriza party in general elections Sunday (January 25), as polls predict. Syriza campaigned that, after taking power, it would abandon a six-year-old austerity program, which its candidates charged imprisoned Greece in a tortuous recession, and then renegotiate terms of debt exceeding €317 billion ($367 billion).

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Source: Heather Stewart, “A New Idea Steals Across Europe – Should Greece’s Debt Be Forgiven?” The Guardian, January 18, 2015.

Buying EU member-countries’ government bonds was the only option left if the ECB was going to increase its balance sheet by €1 trillion, the amount Draghi has supported since last October and the level many analysts perceive necessary to jumpstart the Eurozone. Other recent initiatives lacked the scale today’s program envisions.

Since June last year, EU banks had access (through “long-term funding operations” targeted at job-producing investments) to the ECB’s “free money,” meaning near-zero interest rates. Banks, though, in northern EU countries saw no need, and few companies were interested in shouldering debt while the economy is weak. Late in 2014, the ECB tried more stimulus: an innovative program to buy covered bonds (bank-issued debt collateralized with safe loans) and asset-backed securities (financial instruments backed by assets). Both are small-scale programs, with covered-bond purchases, for example, on track to reach only €200 billion by year-end.

Having Eurozone countries’ central banks shoulder the risks apparently assuaged Germany’s opposition against the ECB buying sovereigns directly. Germany, owning the greatest share of ECB shares as the Eurozone’s largest economy, would have inevitably taken the biggest hit. Two analysts see Germany’s stance as a reflection of the remnants of “ordolilberalism,” a school of thought in Germany emphasizing the state’s need to allow the free market to realize its potential. This thinking was in vogue from the 1940s until the mid-1960s.[1]

“Once the ECB owns large volumes of bonds from crisis countries, it will have an incentive to keep a country solvent even if it has embarked on an unsustainable debt trend,” Sebastian Dullien and Ulrike Guérot wrote in a 2012 paper for the European Council on Foreign Relations. “Ultimately, bond purchases might lead to permanent financing of budget deficits through the central bank, with no instruments left to punish misbehaving governments.”[2]

Efforts to stop both the ECB’s 2012 program and today’s landmark initiative were derailed last week when an adviser to the European Court of Justice essentially swept aside a German court ruling against the ECB’s “Outright Monetary Transactions.” Through that program the ECB bought government bonds of those countries who signed up for bailouts and adhered to austerity regimens overseen by the ECB and the International Monetary Fund. Many credit this effort for saving the euro.

Although a final decision by the ECJ judges is four to six months away, the adviser’s “opinion remove[d] another inconvenient obstacle to Draghi’s big quantitative easing gamble,” said Wolfgang Kunh, head of the European debt division at Aberdeen Asset Management. The court adviser did caution that ECB bond-buying initiatives must include safeguards to avoid financing governments , a prohibition in the European Treaty establishing the ECB.[3]

Hopes that a QE package would be announced had flared before each Governing Council meeting ever since ECB President Mario Draghi gave his “do whatever it takes” speech in July 2012. But opponents inside the ECB strongly argued that the ECB’s large-scale purchases of government bonds would remove disincentives to restrain government spending.

spellman012215 5Source: Economist, “QE in the euro zone.” January 21, 2015.

Investors pushed the euro down to an 11-year low ($1.14), sovereign debt yields moved lower, and European equities set new records in reaction to today’s announcement. Other trends, too, continued to influence market sentiment. The global economy is navigating a new wave of turbulence from Switzerland’s removal of its currency cap, the sharp decline in oil prices, and China’s growth slowdown (the slowest for more than two decades).

Markets had already begun to factor in today’s ECB action – “a done deal” said Citi bank economists -- at least a week ago, as shown by record-low yields for Germany’s 10-year bonds. Some contrarian traders bought options to profit from the market shock they expected if no actions were taken today.[4] This month the euro’s value already hit a nine-year low at $1.17, the same value as when the euro was launched in 1999. Hints of QE by Draghi and governing board members before today’s “salvo” – using their bully pulpit-- helped this to happen, as acknowledged by the IMF’s chief economist, Olivier Blanchard.[5] European stocks had hit a seven-year high Tuesday, according to one index, the Stoxx Europe 600. Germany’s DAX 30 had set an all-time record on Monday.

spellman012215 6Source: Josie Cox, “European Stocks Buoyed by ECB Hopes.” Wall Street Journal, January 19, 2015.

spellman012215 7Source: Mike Bird, “The Euro Is Back Below Its 1999 Launch Value.” Business Insider, January 14, 2015.

Eurozone deflation is a real fear for the ECB. “Europe edged closer to deflation in December, as consumer prices across the European Union’s 28 members fell for the first time since records began in 1997,” the Wall Street Journal reported. “The bloc’s statistics agency [last] Friday confirmed that consumer prices in the 18 countries that share the euro were 0.2% lower than in the same month of 2013. But new figures showed that prices also fell in the EU as a whole, by 0.1%.”[6]

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Source: Economist

Will QE make a difference? Economists are divided over the potential impact.

Buying government bonds will pump more money into the economy, holding down government borrowing rates, which, in turn, makes it less costly for companies to borrow money for modernizing production or launching new ventures. The resulting growth may help fuel inflation, some argue. Even more important is the impact on devaluing the euro, in some analysts’ views. European goods and services will be more competitively priced in global markets. Meanwhile, an unrelated move, lower oil prices, should free up money for Europeans to spend elsewhere.

Paul De Grauwe, the Chair in Political Economy at the London School of Economics, is in this camp, although he doubts whether today’s proposal is sufficient. Channeling €600 billion back into the Eurozone will partially replace the €1 trillion the ECB took out of the region’s economy when banks repaid loans during the 2008-09 debt crisis. Second, there are few if any alternatives.

“In order to raise inflation it will be necessary to increase the growth rate of the money stock,” de Grauwe wrote in his blog post, explaining the monetarist rationale backing the ECB program. “This requires that the ECB increase the money base. And to achieve the latter there is only one practical instrument, i.e., an open-market purchase of government bonds. There is no other way to raise inflation than through an increase in the money base and a bond-buying program is the time-tested way to achieve this.”[7]

Others argue, such as the Germans did in court to block ECB purchases of government bonds, that this initiative will not force governments from excessive borrowing, which was a source of problems for the “peripheral” or “southern” EU members. The program is too late, anyway, they contend.

Frankfurter Allgemeine Zeitung’s Gerald Braunberger asserts in his column, “No, Dr. Draghi,” that QE will not work. “New American studies show that the positive effects of buying government bonds are very probably exaggerated,” he writes.[8]

The problem with today’s proposal is the general problem with any ECB action, contends Richard Werner, a professor at the University of Southampton. “Sadly, the ECB’s track record is one of massive boom-bust cycles, banking crises, mass unemployment and general economic pandemonium,” he writes. He doubts whether lending will increase since interest rates are already “virtually zero.” The flat yield curve, meaning interest rates are relatively the same for short- and long-term loans, is “a disaster for European banks” because they has no incentive to become saddled with long-term, near-zero-interest debt that erodes in value when rates increase, a nearly inevitable outlook. “What is needed is an expansion in bank credit creation,” he argues.[9]

For Draghi, though, investors’ psychology matters most. If he can affirm the strength, depth, and continuity of the ECB’s commitment to promote Eurozone growth, investors will be prone to take risks. His earlier maneuvers – new, cautiously measured programs and semaphores – have already forced down the euro’s value and pushed European equities to new highs. The benefits of these trends will take time to emerge, as will those for today’s initiatives.


[1]Arthur Beesly, “Berlin in constant fear ECB will be lender of last resort.” Irish Times, January 16, 2015.

[2]Sebastian Dullien and Ulrike Guérot, “The Long Shadow of Ordoliberalism: Germany’s Approach to the Euro Crisis.” European Council of Foreign Relations (ECFR 49), February 2012.

[3]Matthew Dalton, “Court Op[inion Moves ECB Closer to Stimulus,” Wall Street Journal, January 14, 2015.

[4]Jamie McGeever, “Contrarians hedge bets as ECB's quantitative easing move next week seen as 'done deal.' ” Reuters, January 15, 2015.

[5]Blanchard said the recent depreciation of the euro is "largely due to anticipation of QE coming down the line." Andrew Walker, “Eurozone prepares for QE.” BBC News, January 21, 2015.

[6]Paul Hannon, “EU consumer prices fall for first time on record.” Wall Street Journal, January 16, 2015.

[7]Paul de Grauwe, “The sad consequences of the fear of QE.” Economist blog, January 21, 2015.

[8]Gerald Braunberger, “No, Dottore Draghi.” Frankfurter Allgemeine Zeitung, January 18, 2015. Stefan Wagstyl, “German media lambast ECB plan for quantitative easing in eurozone. Financial Times, January 19, 2015.

[9]Richard Werner, “ECB is about to implement the wrong type of quantitative easing.” Blog post, January 22, 2015.