When the European Central Bank switches off its money-printing press at the turn of this year and stops buying fresh assets, it will mark the end of a decade-long global experiment in how to stave off economic meltdowns.
Quantitative easing, the policy that aims to boost spending and inflation by creating electronic money and pumping it into the economy by buying assets such as government bonds, is on the verge of becoming quantitative tightening. With the Federal Reserve slowly reducing its stocks of Treasuries, central banks are no longer in the buying business. Globally, only the Bank of Japan is left as a leading central bank that has not formally called time on expanding its stock of asset purchases.
Arguments over how, or even if, the trillions spent by policymakers helped the global economy recover will rage for years to come. But as central banks step back, the initial view is that the purchases worked — whether through encouraging investors to hold more risky assets, easing constraints on borrowing, providing finance so governments could run larger budget deficits or just showing that central banks still had an answer to weak demand and low inflation.
Stephen King, senior economic adviser to HSBC, said: “As rates headed towards zero, QE proved that central banks still had ammunition and were willing to use it. That was incredibly important: without its provision, the fire sale of assets could have been far worse, with grave economic consequences.”
But the policy has proved politically controversial. With the immediate gains flowing to the owners of assets, QE became a lightning rod for criticism from lawmakers keen to press their credentials in combating inequality.
Nowhere has criticism been fiercer than in the eurozone. At one point Wolfgang Schäuble, then Germany’s finance minister, claimed ECB president Mario Draghi had contributed about 50 per cent to the share of votes taken by the rightwing anti-European Alternative for Germany party.
One reason why the ECB began QE so late — it started buying bonds in spring 2015, more than five years after both the Fed and the Bank of England — was concerns from fiscally prudent northern member states that bond purchases would let their more indebted southern counterparts off the hook for what the northern states viewed as years of economic mismanagement.
But even as Mr Draghi drew down the curtain on an era of QE on Thursday, he offered a riposte to that political pressure by saying the policy was now part of the bank’s toolkit.
“It is permanent and may be usable in contingencies that the governing council will assess in its independence,” he said. Legal attacks in Germany had been found wanting by the European Court of Justice, which had, he said, “sanctioned our conviction”.
The end of fresh eurozone QE, despite mounting signs of an economic slowdown, may also help secure its legacy. “No one willingly walks into a room from which there is no exit,” said Melvyn Krauss, senior fellow at Stanford University’s Hoover Institution. “Because QE proved temporary, because it worked and because it has ended, it is likely to be used again.”
The big question now is: what comes next? The policy has created side-effects, producing asset price bubbles and opening up what Mr King describes as a gap between financial hope and economic reality. The gap’s “eventual closure is one of the biggest threats to our economic wellbeing”, he said.
In all countries, the hangover from the crisis has been worse than expected. With inflation often surprising central banks by falling below forecasts, Zsolt Darvas, senior fellow at Bruegel, the think-tank, said that central banks, particularly the ECB, would be wise to follow “a very cautious approach to monetary policy normalisation”.
Yet the lack of normalisation a decade after the crisis means that they have much less firepower to address an economic slowdown than before. Only the Fed has so far raised interest rates significantly — from close to zero to an expected range of between 2.25 per cent and 2.5 per cent next week.
Being left with little room for manoeuvre come the next downturn is an especially serious concern for the ECB, which lags far behind the Fed and BoE in weaning its economy off cheap and plentiful supplies of central bank cash. Many fear the bank will lack both the will and wherewithal to counter any recession once Mr Draghi departs in the second half of 2019.
In an era where the politics of redistribution have taken precedence over raw economic growth, the big risks now stem more from the political climate and less from financial markets. Some think that means politicians should have to take up the slack in future. Laurence Boone, chief economist of the OECD, came out this week in favour of globally co-ordinated fiscal action. “Joint [fiscal] action would send a strong signal to citizens and markets that formal co-ordination can provide solutions,” she wrote in the Financial Times.
If the past decade is any guide, politicians will want central bankers to do the main job of stimulating economies in troubled times again. A decade after they last came to the rescue, there are doubts they can repeat the trick any time soon.
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