31 January 2019

Project Syndicate: Three lessons from QE in Europe

With the European Central Bank having recently ended quantitative easing, three conclusions seem obvious: the ECB’s asset purchases had important macroeconomic benefits; the political costs of QE were much greater than anyone expected; and the whole episode was truly awful for the Bundesbank.

By reducing the cost of bank loans through QE, the ECB encouraged lending to small firms and households across the eurozone. That gave an important boost to economic growth, leading to marked falls in unemployment and upward pressures on wage costs. Although headline inflation rose, underlying inflation remains weak, meaning that the ECB must maintain an expansionary monetary policy.

Furthermore, QE in Europe and elsewhere over the past decade has disproved a number of assertions about central-bank asset purchases. Chief among these is the oft-repeated claim that large-scale central-bank purchases of government bonds invariably results in high inflation. Financial crises lead to a surge in demand for liquidity as financial institutions worry about the solvency of other players. Central banks can and should satisfy that demand by expanding their balance sheets, because not doing so can lead to a collapse in the money stock and a deep recession, as the US Federal Reserve demonstrated in the early 1930s.

Nor are such asset purchases illegal, as some insisted. The ECB, like the Fed and the Bank of Japan (BOJ), is not allowed to buy government bonds in primary markets. But many central banks have long relied on secondary-market bond purchases as their main means of conducting monetary policy. And in December 2018, the European Court of Justice ruled that such purchases do not violate EU law.

The ECJ also debunked the notion, popular in Germany, that QE is fiscal policy rather than monetary policy, and therefore off-limits for the ECB. But the Maastricht Treaty does not define monetary policy, which appears to be determined instead by what central banks actually do in practice. And here, the Fed, BOJ, and many other central banks have all conducted asset purchases in a way similar to the ECB.

But while QE has been effective and its legality is not in doubt, the ECB’s policies have triggered a huge political backlash by making almost all assets more expensive. At first glance, this might seem counter-intuitive. Higher housing prices lead to more building activity, which increases employment. Rising share prices boost the economy by shoring up the balance sheets and confidence of firms, households, and financial institutions. And lower bond yields – the corollary of rising bond prices – make finance cheaper and more available to companies and households alike. [...]

While the economics of QE has been good and the politics bad, the whole episode has been awful for the Bundesbank. In numerous speeches and interviews, its top brass have insisted that QE is unnecessary and raises obvious inflation risks, only to see inflation undershoot the ECB’s target year after year. Bundesbank officials also have argued that low interest rates will trigger financial instability, although this has not happened yet (and tight monetary policy can pose a similar risk). And they have doubted the legality of some of the ECB’s measures, although none of the legal challenges have been successful.

By sticking to its hardline views, despite being unable to persuade the ECB’s Governing Council to change tack on QE, the Bundesbank maneuvered itself into a corner and lost influence and standing. That is why the bank’s president, Jens Weidmann, is not seen as the leading candidate to be the next ECB president, despite his otherwise impressive grasp of economics, top-level experience, and excellent communication skills. The Bundesbank, it seems, has been the main loser from QE.

Full article on Project Syndicate

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