Last Thursday the ECB president, Mario Draghi, announced that the ECB would be in favour of radical measures to stave off the zombie-like state of deflation, including Quantitative Easing (QE). The bond markets greeted this news enthusiastically. The yields on bonds in the prephiery of the Eurozone fell in anticpation of the prospect of being able to sell these toxic instruments to a buyer with potentially infinite resources.
In this respect then the announcment had a beneficial impact on the Euozone’s financial climate, and at a notional cost of zero too. In financial terms at least, it cost the ECB President nothing to utter these words, just as it cost him nothing when he told the world that the ECB would do “whaterever it takes” to support the Euro and the Eurozone.
There are two points worth pondering.
First, the markets will not be satisfied forever with hot air. At some point the words may need to turn into concrete actions. It is not obvious to me, or to many others, whether the German government or the German electorate would be willing to allow the ECB to do “whatever it takes“, especially if this involves the priniting of money to bail out fiscally incontinent peripheral Eurozone governments, who fail year after year to undertake the necessary reforms to make their economies fit to compete in the 21st century’s global economy.
Second, would QE help anyway? The experience of Japan and more recently of the UK, suggest that it might not. Why has bank lending been so weak in the UK since the crisis, after all the Bank of England has pumped huge amounts of cash into the banking system under its QE programme. There are two reasons. The UK’s banks are currently being told by the regulator to shrink their bloated balance sheets – discouraging new lending as a consequence. In addition, why would banks increase lending anyway at a time when the economy is so weak, and the economic future so uncertain? Unless the ECB literally forces banks to lend, any QE-created Euros will simply gather dust in bank vaults, just as the QE pounds are doing in the UK (and the QE yen in Japan).
There are very clear limits to the power of monetary policy. Once they have reached this limit a central banker is left with only bluff and hot air. Take a deep breath Mr Draghi!