Europe: QE remedy is not without side effects

January 22, 2015

The highly anticipated quantitative easing (QE) program of the European Central Bank (ECB) announced on January 22, at first glance, exceeds consensus expectations in terms of size and duration. However, when examining the details more closely, there is considerable doubt that the program will have any noticeable impact on the real economy or quickly combat an extended bout of deflation. Nevertheless, the ECB can claim that its program is similar to the initial offerings of QE by the U.S. Federal Reserve and the Bank of England, with each equaling about 10 percent of GDP. Quantitative easing is an unconventional monetary policy in which a central bank purchases government securities or other securities from the market in order to lower interest rates and increase the money supply.

While the merits of the program will be debated for some time, there are two important takeaways that could have a significant impact on efforts to revitalize the Eurozone. The first is the decision to limit loss sharing in the face of hypothetical default on sovereign debt purchased as part of the QE program.[1] This decision should be viewed as an obstacle and sign of reluctance to push for further integration. For not only does it derail efforts to promote mutualization of debt, but also raises serious doubt about possible moves toward fiscal union. Many economists and policy makers believe that the ultimate success of the euro and the European Union more broadly will depend on further integration that goes beyond that achieved with the recent agreement on a banking union.

The second takeaway from the QE program is that all pretense of independence of the ECB has vanished. For many, the QE program is a day late and a euro short because of the need for ECB President Mario Draghi to cajole the leadership of Germany to accept, however grudgingly, the need for some form of QE. The inability to agree on more risk sharing is a clear indication of German unwillingness to make potential financial commitments to raise the credibility of Eurozone-wide policies and their strong intent to do what is in the best interest of Europe, despite opposition at home. The lack of imagination and aggressiveness in the QE program should leave little doubt that the limits of ECB monetary policy have been reached and that political leaders will have to find other ways to restore economic growth and prosperity to Europe.    

[1] The QE program states that “With regard to the sharing of hypothetical losses, the Governing Council (of the ECB) decided that purchases of securities …. implies that 20 percent of additional asset purchases will be subject to a regime of risk sharing.”