By George Theocharides
Cyprus International Institute of Management
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.
George Theocharides is Associate Professor of Finance and Director of MSc in Financial Services at the Cyprus International Institute of Management (CIIM) www.ciim.ac.cy