Thursday, September 4, 2014

Why QE might be a bad idea for the eurozone

Michael Heise, chief economist at Allianz, is against (FT) quantitative easing by the ECB. He thinks the ECB shouldn't go down the QE route, because:

First, the recent low inflation rates are in part a result of the decline in oil and other commodity prices. They also reflect necessary adjustments in the eurozone periphery. [...] There is no sign of a vicious circle of falling inflation expectations and consumer restraint. Inflation rates will gradually climb again as the economy recovers.

Second, although the ECB has several options when it comes to implementing QE, there are serious objections to all of them. Buying asset-backed securities or corporate bonds would expose the European taxpayer to credit risk.


Third, the impact of further monetary easing on output and price levels would be negligible. That is because the recession in many parts of the eurozone is caused by the hobbling effect of the unsustainable amounts of debt that were built up by public and private actors during the boom years. Over-indebted households and companies are unlikely to pile up more debt; on the contrary, they are trying to pay it down. This makes monetary policy ineffective.

Fourth, the collateral damage from ultra-loose monetary policy is accumulating. Risks to financial stability are growing as investors are piling into riskier assets in search of higher returns. Already, some assets such as junk bonds are trading at what look like inflated prices.

Fifth, further monetary easing would delay the much-needed adjustments in the balance sheets of European banks and companies. An abundance of cost-free liquidity from the central bank enables commercial lenders to continue propping up weak creditors.
Of those, I agree most with #1. A breakdown of the eurozone's consumer price index suggests that a good chunk of Europe's deflationary pressure is "imported," showing up in the price index of goods with a high component of commodities. The price index of services, on the other hand, many of which are non-tradable, doesn't indicate deflation. (More on this soon.) Yes, demand is weak, and the private sector is deleveraging, but a lot of the "deflation" problem has to do with declining prices of globally traded goods, and the appreciation of the euro between 2012 and 2014, which only started to reverse itself in May.

Of the other reasons offered by Heise, I agree with #4. I'm sympathetic with #3 (further easing will be ineffective), but I stress a different obstacle: banks are under pressure to clean up their balance sheets. In that sense, European policy is schizophrenic. On one hand, the ECB is trying to encourage more lending; on the other, regulators tell banks to improve their equity ratios.

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