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DING CHUN: QE alone unable to tackle problems in Europe

| 2015-03-05 | Hits:
(Chinese Social Sciences Today)

On Jan. 22, President of the European Central Bank (ECB) Mario Draghi announced a long-awaited round of quantitative easing (QE) that includes a €60 billion-a-month bond-buying program starting from March this year to September next year, with the possibility of an extension. The package, including bonds issued by national governments and EU institutions, will amount to about €1.1 trillion.

In fact, the bank had introduced its Outright Monetary Transactions program as early as September 2012. However, the monetary policy was strongly opposed by core EU member states like Germany because of fears that it would shift the financial burdens of heavily indebted members such as Greece onto other countries and increase the risk of moral hazard.

As far as I’m concerned, three reasons have contributed to the launch of QE in Europe at the beginning of the year.

First, though the European debt crisis is over in the narrow sense, there has been a stronger push for deflation and pump-priming policies in the peripheral eurozone countries that have sluggish economies and even in France. Moreover, the sanctions and counter-sanctions between the EU and Russia, the mighty recovery and the end of QE III in America, and the sharp decline of international crude oil prices have led to a weak recovery, high unemployment and even deflation in the EU and the eurozone in particular.

According to the EU autumn forecast, the growth rate of the eurozone’s economy last year was only 0.8 percent, unemployment rate was up to 11.6 percent and the inflation rate was only 0.5 percent. Economists have issued dire warnings that the European economy is headed toward a long-term downturn like what Japan once experienced.

Second, the previously implemented measures such as the two targeted long-term refinancing operations, had little effect on stimulating the economy because consumers and investors are hesitant to take out loans due to low expectations.

Third, having gained ground in the 2014 European Parliament election, Eurosceptic and anti-immigration parties may come into power if member economies continue to falter, which would greatly sabotage the European integration.

After compromising with states like Germany, the Netherlands and Austria against large-scale QE, the ECB went forward with the monetary policy, the largest of its kind in history, and acted as the lender of last resort before the 2015 Greek election.

The European QE addresses the concerns about the moral hazard raised by Germany and the Netherlands while giving aid to heavily indebted states, thus helping restore confidence in the markets. It includes several compromises and is more nuanced compared with the monetary policies in America and other regions.

No doubt, the QE will boost expectations for the European economy and promote the recovery. However, problems in terms of mechanism and feasibility can constrain its implementation and effect.

First, there is a divergence of interests and circumstances among the peripheral and core member states, and as a result, there is ongoing debate over stimulation or austerity, thus restricting the effect of the QE. The core countries are worried about the potential for moral hazard created by the QE. As a matter of fact, countries in urgent need of financing like Greece are unable to raise enough funds due to limitations on financing proportion, varieties of bonds and coinsurance percentage. On the contrary, core countries like Germany, though qualified, are unwilling to take loans.

Second, the effect of the QE as a monetary policy relies to a large extent on the economic situation and its coordination with other policies and fiscal policy in particular. Before the launch of the QE, the negative interest rate arose as the ECB cut the benchmark refinancing rate repeatedly, and the national debts of most nations had low yields.

As a result, consumers and investors have low expectations for economic growth and are taking a wait-and-see attitude, which has complicated efforts to promote economic recovery and prevent deflation. Whether the QE can restore the confidence of investors and consumers remains to be seen.

Third, the implementation of the QE in Europe, to a certain extent, will help reduce the costs of peripheral nations with heavy debt and help them obtain relatively ample capital, but it will necessarily weaken their incentive to conduct structural reform. Moreover, there are other problems, such as rigid labor markets, excessive social welfare, lack of innovation incentives and entrepreneurship, and too much bureaucracy in member states, including France.

If these problems are not taken seriously and dealt with, the QE alone just gives structural reform a chance to breathe and cannot help stimulate private consumption and investment, let alone help the economy get out of stagnation, recover and grow.


Ding Chun is Jean Monnet Chair and the director of the Center for European Studies at Fudan University.