Eurozone crisis: Will quantitative easing work?

By Mahfuz Kabir

Once Einstein said, “Insanity is doing the same thing over and over again but expecting different results”. Exactly in an opposite story, Robert Bruce spoke about a spider that tried seven times to eventually succeed in spinning her web. However, economists are in-between. They have scientifically rigorous theories and models which are proved in laboratories but not working like physical science. These are aimed to explain the mysteries and address the economic ailments. The economic medications are put on trial time and again to get different results.

Bailout packages are sometimes perceived as a ‘shock therapy’ to severe macroeconomic downturns. In the last century, the first popular mega bailout package called ‘the big deal’ was followed by the Great Depression bulldozing the Western economies. We also witnessed the extensive heats of global financial crisis that had to resort to $70 billion mega bailout package in the United States.

There are debates over the effectiveness of bailouts to pull off the aggregate demand and rejuvenate market forces that are two mantras in the heart of capitalism. Notwithstanding, the European Central Bank (ECB) starts a gigantic dose of medicine worth around €1.1 trillion or US$1.2 trillion in its Quantitative Easing (QE) programme, which primarily aims at buying sovereign debts of €850 billion of the region. It also includes buying private sector assets and the debt of eurozone institutions.

The QE programme of ECB is regarded as the biggest recovery initiative of the present time, starting from March 2015 to June 2016. The ECB would be able to buy 20 per cent of sovereign bonds, and the rest is kept for individual central banks while they are allowed to purchase as many securities as is necessary. It is mainly targeted to give a significant boost to eurozone through countering expected deflationary pressure, i.e., massive collapse of prices emanating from continued recession and stagnation across euro economies. The apprehension had a solid ground – consumer prices in the 19 euro countries fell by 0.2 per cent in December 2014 alone, which was supposed to be the opposite as it was a festive period. The US already appreciated the initiative and is expecting its positive spill-over effect on its economy as Dow Jones industrial average was raised by 259.7 points or 1.5 per cent in a day immediately after the QE announcement. European and Asian markets also showed a generally positive effect.

Yet, started with East Asian crisis, this pandemic hits EU, the largest regional bloc that gave rise to a formidable challenge to the theory of economic integration: is economic regionalism financially viable at any stage of evolution? It is because of unprecedented scale and pace of the crisis that unbelievably weaken the strongest economies of the zone as well. Therefore, the remedial measure has turned out to be gigantic unprecedentedly with considerable risk of incurring losses. Thus, QE can be seen as an effort to formalise the spread of sovereign burdens across the region as a public good (or bad) to weaken the whole system.

Critics have already started mentioning the possible negative consequences as some of the central banks of the region including Germany bought bonds in prices that are likely to incur loss if these are held up to maturity. The initial symptom is also in favour of this apprehension as the bonds eligible for QE are being traded in stronger economies like France, the Netherlands, Finland, Belgium, Austria and Slovakia at negative yields. There is also an uncertainty over ECB’s selling out of bond worth €60 billion per month for buying public and private assets. Thus, there is a big question of credibility of the term in which the ECB is targeting the volume of bonds.

There is also a considerable risk of disintegration in Europe’s monetary policy, and increased crisis through exchange rate channel with other European countries. For example, Switzerland currently has the highest per capita foreign exchange reserve, and franc witnessed 40 per cent appreciation against the euro since 2011. Thus, QE is likely to escalate the gap between core and peripheral economies, and between the EU and other European countries.

Theoretically, the QE is expected to bring in a situation where everyone wins: encouraging businesses to invest in which more capital and labour are employed, and additional cash flow to both consumers and producers pull off the aggregate demand. The ECB assumed the QE to heal the moribund economies of the zone through influx of money that is expected to work as anti-austerity. Why was it so necessary? Was it because of sharp depreciation of euro, disinvestment, and alarmingly falling aggregate demand emanating from massive austerity and unemployment that can compel one to think after six decades of a rather deep integration: it is better to remain alone than united? The UK premier has categorically indicated in that direction to reform relationship with the EU a few months back.

Does QE have anything to do with the real economy just through penetration of money, inserting again and again like ‘insanity’? The response lies with how it is linked with the economy. It works as per neo-Keynesian paradigm if money it is channelled directly to productive activities, thereby increasing output growth and having positive effect on the labour market. Otherwise, printing euro would just be absorbed for nothing with inflation triggered as it is seen as a high-risk strategy working like a passage for inviting inflation expectations. Therefore, serious measure towards structural reform is badly needed to help reshape economies and rise naturally without negative spill-over. It would pave the way to work even in the last month of the programme like Bruce’s spider.