Europe needs quantitative easing but that monetary policy alone will not restore growth and jobs to the region, that’s according to a panel debate of business leaders and policy-makers, held at the World Economic Forum in Davos, Switzerland, yesterday.
“We’re all for quantitative easing in Europe, but it’s not enough,” said Lawrence H. Summers, Charles W. Eliot University Professor, Harvard University, USA. Summers said that quantitative easing was likely to be less effective in Europe than it was in the US since Europe already has very low interest rates and European banks are less able to transmit monetary expansion to the wider economy. Summers urged Europe to embark on fiscal stimulus and said that “deflation and secular stagnation are the risks of our time”.
Gary D. Cohn, President and Chief Operating Officer, Goldman Sachs, USA, said that the US economy is strong but weakness elsewhere would make it hard for the Federal Reserve to raise interest rates. He said the dollar’s strength, which could have a chilling effect on the US economy, would also encourage US monetary authorities to keep rates low. “We’re in a currency war. One of the easier ways to stimulate your economy is to weaken your currency,” he said.
Ray Dalio, Chairman and Chief Investment Officer, Bridgewater Associates, USA, said that a weaker currency has to be part of the solution for Europe’s problems, given many European countries’ lack of competitiveness. “Forceful QE and forceful structural reforms, including currency adjustment, are what is needed,” he said. Dalio expressed concern that with interest rates at or near zero, central banks have lost their traditional method for stimulating economies. Fiscal policy now must work together with monetary policy to stimulate growth. “Monetary policy that helps fund deficits, that monetizes the deficits, is a path to consider.”
Dalio added that “Spain has done a wonderful job with structural reforms. It is a model.” He noted that the fastest growth often comes from countries that successfully implement structural reforms, such as China in the recent past.
Christine Lagarde, Managing Director, International Monetary Fund (IMF), Washington DC; World Economic Forum Foundation Board Member, also complimented Spain on its reforms. She said that Europe’s monetary union is still quite young but has nonetheless moved forward quickly. “Massive progress has been made in the last five years. More progress has to be made in terms of fiscal union and banking union.”
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“I am confident that Europe can make it,” added Ana Botín, Chairman, Banco Santander, Spain. She said Europe is now seeing a great deal of foreign investment, including in her own bank’s recent capital rise. Some European countries are successfully implementing structural reforms to increase competitiveness. Automobile factories in Spain are now more productive than those in Germany. “We are making progress,” she said. “It takes time for a region to unify.”
This afternoon, Mario Draghi, President of the European Central Bank (ECB) announced the much awaited outcome of the Governing Council’s meeting on quantitative easing (QE) for the Eurozone economy.
First, the ECB is to launch an expanded asset purchase programme, encompassing the existing purchase programmes for asset-backed securities and covered bonds. The expanded programme will see monthly purchases of €60 billion set to run for 18 months or until required.
Starting March, the Eurosystem will start to purchase euro-denominated investment-grade securities issued by euro area governments and agencies and European institutions in the secondary market. The purchases of securities issued by euro area governments and agencies will be based on the Eurosystem NCBs’ shares in the ECB’s capital key.
Second, the Governing Council decided to change the pricing of the six remaining targeted longer-term refinancing operations (TLTROs). More details will be released on this later.
Third, a decision was taken to keep the key ECB interest rates unchanged. The main interest rate remains at 0.05%, the marginal lending rate stays at 0.3% and the deposit rate at -0.2%.
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“Today’s monetary policy decision on additional asset purchases was taken to counter two unfavourable developments. First, inflation dynamics have continued to be weaker than expected. While the sharp fall in oil prices over recent months remains the dominant factor driving current headline inflation, the potential for second-round effects on wage and price-setting has increased and could adversely affect medium-term price developments. This assessment is underpinned by a further fall in market-based measures of inflation expectations over all horizons and the fact that most indicators of actual or expected inflation stand at, or close to, their historical lows. At the same time, economic slack in the euro area remains sizeable and money and credit developments continue to be subdued,” stated Mario Draghi, President of the ECB.
“Second, while the monetary policy measures adopted between June and September last year resulted in a material improvement in terms of financial market prices, this was not the case for the quantitative results. As a consequence, the prevailing degree of monetary accommodation was insufficient to adequately address heightened risks of too prolonged a period of low inflation. Thus, today the adoption of further balance sheet measures has become warranted to achieve our price stability objective, given that the key ECB interest rates have reached their lower bound.”
According to Mr Draghi, today’s measures will decisively underpin the firm anchoring of medium to long-term inflation expectations.
“The sizeable increase in our balance sheet will further ease the monetary policy stance. In particular, financing conditions for firms and households in the euro area will continue to improve. Moreover, today’s decisions will support our forward guidance on the key ECB interest rates and reinforce the fact that there are significant and increasing differences in the monetary policy cycle between major advanced economies. Taken together, these factors should strengthen demand, increase capacity utilisation and support money and credit growth, and thereby contribute to a return of inflation rates towards 2%.”
The finance industry has been quick to pass comment on the QE measures.
“The size of the ECB’s programme, combined with its potentially open-ended nature, should convince markets that Mario Draghi is committed to fighting deflation,” said Ben Brettell, Senior Economist, Hargreaves Lansdown.
“In many ways the fact that Draghi has finally been forced to use his silver bullet is a measure of how bad the economic situation in Europe has become. Bundesbank officials have made it clear they don’t think economic conditions warrant QE, but few outside Germany would agree that today’s measures are anything less than necessary.”
John Cridland, CBI Director-General, said: “At the moment, flagging Eurozone economies are dragging on UK and world growth. QE will give the Eurozone recovery a much-needed boost, which should also have a positive economic effect in the UK.
“To gain maximum effect though, this action must go hand-in-hand with structural reform. France needs to work with the business community to modernise its labour rules and Germany should invest more in infrastructure.”
While QE has been largely welcomed, Europe faces another challenge later this week when Greece goes to the polls. A victory for the anti-austerity Syriza party could escalate ‘Grexit’ fears amid negotiations over new bailout terms when the current deal expires in February.
