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During a lengthy deliberation the ECB has faced heavy criticism for allowing eurozone inflation to slip into negative territory, and well below its target of close to 2 per cent, before pressing ahead with QE. But there is one advantage to being last: policy makers in Frankfurt had the luxury of reflecting on the experience of the Bank of Japan, the US Federal Reserve and the Bank of England to assess the impact of asset purchases.
The good news is that, by most accounts, QE appears to have succeeded at boosting growth and lifting inflation. Martin Weale, a member of the BoE’s interest-rate setting Monetary Policy Committee, found asset purchases worth 1 per cent of national income boosted UK gross domestic product by about 0.18 per cent and inflation by 0.3 per cent. A study by John Williams, president of the San Francisco Federal Reserve, concluded that asset purchases had reduced the US unemployment rate by 1.5 percentage points by late 2012 and helped the economy avoid deflation.
Still, there are at least four reasons why the ECB’s version of QE will be very different — and potentially less effective — than those elsewhere.
Central banks purchase large quantities of sovereign bonds as they seek to lower their yields and push investors into riskier assets.
However, interest rates on eurozone bonds have come down sharply since Mario Draghi, ECB president, announced in July 2012 that he would do “whatever it takes” to keep the single currency intact. Yields have continued to fall over the past few months, thanks to slumping inflation and investors’ anticipation of QE.
Today, Italy’s and Spain’s 10-year bonds yield about 1.5 per cent, about half the interest on equivalent US treasuries and UK gilts when the Fed and the BoE announced their own QE programmes. The scope for further decline is therefore limited.
The role of the banks
QE should help businesses by lowering the cost at which they can borrow money. In theory, this should be true regardless of whether corporates raise funds via a bank or directly on the capital markets: in either case, central bank purchases of sovereign debt make government paper less attractive, pushing investors to lend their money elsewhere.
However, work by Nick Butt of the BoE and colleagues has shown that, at least in the UK, QE has not succeeded in boosting lending. The trouble for the ECB is that eurozone businesses are heavily reliant on the banking sector, more so than their US competitors. For every €10 borrowed by European corporates, about eight come from a bank and only two from the capital markets. In the US, it is the other way round.
The success of the ECB’s programme will therefore hinge on the banks’ willingness to lend. On Tuesday, the central bank’s quarterly lending survey revealed that credit standards in the eurozone eased in the past three months of 2014 but remain tight by historical standards.
Many economists believe that the single most important channel through` which QE will operate in the eurozone is the currency. Asset purchases will reduce interest rates on euro-denominated bonds, prompting investors to search for yields abroad, which will lower the value of the euro. Indeed, markets have already anticipated some of these effects, with the euro falling to 1.16 against the dollar, about 15 per cent below the average of the first half of last year.
The experience of other central banks, however, offers a cautionary tale of how much QE-induced depreciation can help to boost exports. While asset purchases by the BoE have helped to keep the value of the pound low, the UK has continued to run stubbornly high trade deficits. And as Raoul Ruparel of Open Europe, a think-tank, has shown, the steep devaluation of the yen since 2012 has failed to spur any significant increase in Japanese exports.
One reason for this disappointing performance is the changing nature of international trade. “A lower share of goods’ value is now produced in the euro area territory. This suggests that the improvement in price-competitiveness that stems from a lower euro is less important than in the past,” wrote Michala Marcussen and colleagues of Société Générale in a research note.
Central bank politics
When the BoE and Federal Reserve embarked on their QE programmes, their interest-rate setting bodies rallied unanimously behind the new policy. While Haruhiko Kuroda, BoJ governor, did not enjoy this luxury, his flagship monetary stimulus in April 2013 faced only one dissenter.
Mr Draghi is unlikely to be as lucky as his colleagues. Jens Weidmann, Bundesbank president, is widely expected to oppose any QE programme on the grounds that it is excessively risky and would relax the pressure on governments to reform. Sabine Lautenschläger, the German executive board member, has also expressed her scepticism.
These divisions matter as they will curtail the scope of the programme, for example forcing the ECB to set limits over how much risk-sharing there will be on the bond purchases.