Will Draghi’s QE pro­gramme work?

Financial Mirror (Cyprus) - - FRONT PAGE -

The re­cent an­nounce­ment by Mario Draghi for the Quan­ti­ta­tive Eas­ing (QE) pro­gramme in Europe was wel­comed by an ex­pected eu­pho­ria from the fi­nan­cial mar­kets. Stock mar­kets around the globe pro­duced pos­i­tive and sig­nif­i­cant re­turns, while yields on the sovereign bond mar­kets ex­hib­ited sharp de­clines. This was a long-awaited de­ci­sion by the ECB which was de­layed for some time due to the stub­born­ness of Ger­many to al­low such a pro­gramme, fear­ing that it might lead to a halt in struc­tural re­forms from the coun­tries that need them the most.

In the end, “su­per” Mario Draghi re­sisted the Ger­mans’ ob­jec­tions and an­nounced a pro­gramme that was even big­ger than what the mar­ket ex­pected; EUR 60 bln per month in as­set pur­chases by the ECB from the sec­ondary mar­ket, from March 2015 un­til Septem­ber 2016, for a to­tal amount of around EUR 1.1 trln. This is fresh money pumped into the Euro­pean econ­omy, and the ques­tion is what will be the likely im­pact of this pro­gramme, and whether it’s enough to re­vive the Euro­pean econ­omy.

The aim of QE is three-fold: (1) battle de­fla­tion, and pro­duce a level of in­fla­tion close, but lower, than the 2% rate which is the man­date of the ECB; (2) cre­ate growth and re­duce un­em­ploy­ment; and, (3) lower sovereign bond yields to make it eas­ier for coun­tries to ac­cess the fi­nan­cial mar­kets. Whether the pro­gramme will achieve its goals de­pends to a large ex­tent on how the fresh money is used and whether it’s chan­nelled into the real econ­omy. Sovereign bonds are held by the cen­tral bank, de­pos­i­tory in­sti­tu­tions (banks, sav­ings and loan as­so­ci­a­tions, credit unions), deal­ers and bro­kers, pen­sion/prov­i­dent/in­vest­ment funds, in­sur­ance com­pa­nies, in­di­vid­ual in­vestors, as well as for­eign gov­ern­ments and other in­sti­tu­tions. The way that th­ese in­vestors use the fresh money is­sued by the ECB is en­tirely based on their pref­er­ences.

For ex­am­ple, if a bank that sells gov­ern­ment bonds to ECB de­cides to use the fresh money to in­crease its cash bal­ance, or re­pay back some li­a­bil­i­ties (for ex­am­ple, ECB fund­ing), then that would not cre­ate growth and in­fla­tion in the do­mes­tic econ­omy. Fur­ther­more, there might not be ad­e­quate de­mand for the banks to lend out this new money. As far as the bond yields are con­cerned, I think this is achiev­able. Just the an­nounce­ment by ECB has low­ered sig­nif­i­cantly the sovereign bond yields, and a fur­ther drop will prob­a­bly oc­cur once the pro­gramme com­mences.

Over­all, econ­o­mists and ex­perts are not clear whether QE is a right pol­icy to fol­low. How­ever, the re­cent ex­am­ple of the QE pro­grammes (a to­tal of three pro­grammes) im­ple­mented in the US led to a fast re­cov­ery of the US econ­omy. Cer­tainly print­ing more money by cen­tral banks, although it can in­crease in­fla­tion, is not a long-term so­lu­tion. Coun­tries need to im­ple­ment their struc­tural re­forms, there needs to be fis­cal pru­dence, and as a re­sult they will make their econ­omy more com­pet­i­tive. And I think here lies one of the main prob­lems with the Euro­pean econ­omy. Europe lost its com­pet­i­tive­ness to other parts of the world, and there is not enough in­no­va­tion. Fur­ther­more, there is no fis­cal union and a bank­ing union that only re­cently has been put in place.

My per­sonal opin­ion is that QE will help, but gov­ern­ments (es­pe­cially in south­ern Europe) need to con­tinue with their struc­tural re­forms and fis­cal ad­just­ment. Fur­ther­more, Europe can ben­e­fit from in­vest­ment ini­tia­tives such as the EUR 315 bln Juncker plan that was an­nounced last De­cem­ber. Mon­e­tary eas­ing bun­dled with EU-led in­vest­ment plans and a con­tin­u­a­tion of the struc­tural re­forms to be­come more com­pet­i­tive might be the way for Europe to re­vive its ail­ing econ­omy.

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