{"id":11533,"date":"2015-01-21T14:00:23","date_gmt":"2015-01-21T19:00:23","guid":{"rendered":"http:\/\/multiplier-effect.org\/?p=11533"},"modified":"2015-01-21T14:07:36","modified_gmt":"2015-01-21T19:07:36","slug":"it-seems-qe-is-finally-coming-to-euroland-will-it-matter-at-all","status":"publish","type":"post","link":"https:\/\/blogs.bard.edu\/multiplier-effect\/it-seems-qe-is-finally-coming-to-euroland-will-it-matter-at-all\/","title":{"rendered":"It Seems QE Is Finally Coming to Euroland\u2014Will It Matter at All?"},"content":{"rendered":"

When French president Fran\u00e7ois Hollande pre-announced the ECB Governing Council\u2019s long-awaited adoption of \u201cquantitative easing\u201d at its meeting tomorrow<\/span>, German chancellor Angela Merkel was quick to respond by pointing out that this was still the independent ECB\u2019s decision alone. It was good of her to do so. For in recent times one could not help getting the impression that the German political elite had forgotten all about that precious centerpiece of German monetary orthodoxy: that the independence of the central bank was the most important safeguard of solidity in the world.<\/p>\n

Against the background of an ill-informed German public and an ideology-stricken German media landscape that excels in nothing more than keeping alive hyperinflation phobia even as the land of the euro is at acute risk of sinking ever deeper into the morass of deflation, Germany\u2019s body politic got carried away with their self-righteous assumption that it was in everyone\u2019s best interest to accept the reality of German hegemony over Euroland in all matters of economic policy, including monetary policy. Yesterday\u2019s Financial Times<\/em> quoted<\/a> the former ECB governing council member Athanasios Orphanides on what would appear to be a rather intolerable (since illegal) state of affairs: \u201cIt is as if it\u2019s accepted that the euro area\u2019s modus operandi is to clear things with Germany, and for the ECB to constrain its actions to what is best for Germany \u2026 This is inconsistent with and violates the [EU] treaty.\u201d<\/p>\n

So if the ECB finally goes ahead tomorrow with some kind of QE, ignoring German resistance, what will QE actually do for Euroland?<\/p>\n

Let\u2019s briefly consult Keynes on this, who reflected on QE in his monetary writings as a means to directly influence financial conditions beyond the short rate set by the central bank anyway. Both in his Treatise on Money<\/em> and in The General Theory<\/em> Keynes distinguished two scenarios: whether the banks support the central bank\u2019s efforts or whether the central bank has to go it alone.<\/p>\n

In the first case, the impact on the central bank\u2019s own balance sheet might turn out to be very limited as the banks\u2019 purchases help moving long-term rates in the desired direction. What might prevent the banks from doing so? Keynes focuses on one obstacle in particular: the banks\u2019 fear of future financial losses in case interest rates \u201cnormalize\u201d again later on. This is a fundamental obstacle because if monetary policy turns out to be successful in overcoming the slump, a normalization of interest rates could be reasonably expected. In other words, there is an inherent time-inconsistency problem involved here. Keynes\u2019s advice in the Treatise<\/em> is that, if necessary, it is the authorities\u2019 duty to ignore potential future losses of QE and do the utmost to overcome the crisis. The key additional insight offered in The General Theory<\/em> is that the \u201clong-period norm\u201d (the level towards rates would tend to \u201cnormalize\u201d again later on) is not fixed (or uniquely determined by those real forces of thrift and productivity), but itself a market convention that is subject to the expectations management of the central bank. If the central bank convinces the markets that yields will stay low for a long time, it may be the banks that carry out the purchases actually driving down the yields, and with little change for the central bank\u2019s own balance sheet. By contrast, a \u201cliquidity trap\u201d scenario describes the case in which the central bank ends up going it alone, expanding its own balance sheet through asset purchases \u201c\u00e0 outrance,\u201d while the banks prefer watching their liquidity rise instead as they are unconvinced that they would be able to carry the trade without future financial loss.<\/p>\n

Keynes goes one step further in The General Theory<\/em>, suggesting that the central bank could use an even more direct method of establishing \u201cthe\u201d rate of interest it considers appropriate given the state of the economy, observing that \u201cperhaps a complex offer by the central bank to buy and sell at stated prices gilt-edged bonds of all maturities, in place of the single bank rate for short-term bills, is the most important practical improvement which can be made in the technique of monetary management\u201d (Keynes 1936, p. 206). His later war-time writings and outlook for the postwar era (featuring a huge U.K. public debt and foreign debts owing to the war efforts) followed this line of thought.<\/p>\n

While it is generally accepted today that the central bank is the de facto monetary \u201ccentral planner\u201d setting the short-term rate of interest that anchors financial conditions, directly setting the whole term structure (and risk structure) of interest rates would be assured to run into trouble with what the Maastricht Treaty says about the requirement of economic policy to adhere to the principles of a \u201cmarket economy.\u201d So the ECB will have to restrain itself, directly setting only the short rate, but relying on expectations management \u2013 backed up by actual asset purchases (QE) if necessary \u2013 to steer financial conditions in the desired direction.<\/p>\n

The remarkable thing is how far the \u201cmagician\u2019s\u201d successful expectations management alone has pushed yields and yield spreads down at this point, purely in anticipation of QE (given the unfolding deflationary economic environment). How much more can actual QE deliver at this point? Assuming that the ECB does not disappoint, and market expectations seem to be for a \u20ac500 billion program, I suspect rather little in terms of bond yields and spreads. If banks (and others) are tempted to offload to the ECB and take profits, is there going to be a big splurge into risky assets? In particular, are banks going to boost their lending to euro area SMEs, assuming that SMEs want to borrow more? The ECB\u2019s latest Bank Lending Survey showed some improvement, but protracted demand stagnation and falling prices have created mounting balance sheet strains for the euro area private sector.<\/p>\n

In the end, it will largely depend on whether the public sector is finally changing track and ends its insane austerity crusade. An important part of monetary policy lowering interest rates in a crisis is to prevent a rising interest burden from triggering counterproductive fiscal austerity. Lowering the public sector\u2019s interest burden as such actually means reducing incomes. This can only be expansionary if falling interest rates encourage more spending overall. If the euro area fiscal authorities fail to use the windfall of a lower interest burden by embarking on something more constructive, a meaningful infrastructure initiative in particular, it will all come to nothing. In fact, add the insane idea of everyone becoming more competitive to the insane idea of everyone balancing their public budget, and the ECB can carry out QE until it is blue in the face without ever stopping deflation. In that case, QE amounts to one thing only: currency warfare! And Mr. Draghi\u2019s words have been disturbingly effective in that regard too.<\/p>\n

In short, QE per se is not a panacea for Euroland\u2019s ills. What matters is whether Euroland will also end their other foolish policies or simply remain on track for \u201cmore of the same.\u201d Note that Germany opposes QE for fear that it might discourage its euro partners from carrying on with the \u201cmore of the same\u201d folly …<\/p>\n","protected":false},"excerpt":{"rendered":"

When French president Fran\u00e7ois Hollande pre-announced the ECB Governing Council\u2019s long-awaited adoption of \u201cquantitative easing\u201d at its meeting tomorrow, German chancellor Angela Merkel was quick to respond by pointing out that this was still the independent ECB\u2019s decision alone. It was good of her to do so. For in recent times one could not help […]<\/p>\n","protected":false},"author":187,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[15,40],"tags":[996,952,121,31,34,340,398],"class_list":["post-11533","post","type-post","status-publish","format-standard","hentry","category-eurozone-crisis","category-monetary-policy","tag-central-bank-independence","tag-draghi","tag-ecb","tag-eurozone","tag-keynes","tag-monetary-policy-2","tag-qe"],"jetpack_featured_media_url":"","_links":{"self":[{"href":"https:\/\/blogs.bard.edu\/multiplier-effect\/wp-json\/wp\/v2\/posts\/11533","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/blogs.bard.edu\/multiplier-effect\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/blogs.bard.edu\/multiplier-effect\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/blogs.bard.edu\/multiplier-effect\/wp-json\/wp\/v2\/users\/187"}],"replies":[{"embeddable":true,"href":"https:\/\/blogs.bard.edu\/multiplier-effect\/wp-json\/wp\/v2\/comments?post=11533"}],"version-history":[{"count":6,"href":"https:\/\/blogs.bard.edu\/multiplier-effect\/wp-json\/wp\/v2\/posts\/11533\/revisions"}],"predecessor-version":[{"id":11539,"href":"https:\/\/blogs.bard.edu\/multiplier-effect\/wp-json\/wp\/v2\/posts\/11533\/revisions\/11539"}],"wp:attachment":[{"href":"https:\/\/blogs.bard.edu\/multiplier-effect\/wp-json\/wp\/v2\/media?parent=11533"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/blogs.bard.edu\/multiplier-effect\/wp-json\/wp\/v2\/categories?post=11533"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/blogs.bard.edu\/multiplier-effect\/wp-json\/wp\/v2\/tags?post=11533"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}