QE on its own is just not enough

Article by Brian Hayes MEP published in the Sunday Business Post on Sunday 6th September 2015.

6 months into Quantitative Easing is it making any difference?

In monetary policy, you shouldn’t meddle too deeply in things you cannot control. Aggressive monetary policy instruments like quantitative easing cede almost complete control to the markets and once initiated, can be difficult to control. Look at Japan for instance – QE was initiated in Japan in the 1990s and for almost the past two decades the central bank has offered near zero rates and is in a seemingly inescapable deflationary cycle. There was a real threat this week that the Swedish Central Bank would cut rates which would have been extraordinary given the central bank is already paying banks to borrow money. Interest rates are currently minus 0.35 percent.

In May, just two months after QE began, the Eurozone’s inflation rate had climbed to 0.3% and for the following 3 months it has flatlined at 0.2%. This is a tell-tale sign that Quantitative Easing is not having the desired impact. Central Bankers use inflation as the clearest yardstick to assess their actions. Mario Draghi says that the ECB’s target is to get the Eurozone’s inflation rate below, but close to, 2% over the medium term. This has now clearly become a bridge too far to gap. And now we risk a long period of low inflation given the collapse of the Chinese stock market and the threat to growth all across the world.

Aggressive monetary policy also poses serious difficulties in a bloc of countries that are so different. The Eurozone has 19 Member States who all have different banking systems and different fiscal policies. Although the ECB is buying government bonds in a proportional manner through QE, that proportionality does not reflect the differences in economic conditions that each Member State faces.

So how has Ireland fared in the Quantitative Easing story? It can be reasonably argued that Ireland is in pole position to benefit from Quantitative Easing – Ireland’s borrowing costs are at almost record lows on the back of QE and Irish exporters can take full advantage of a weaker euro which has come about from the ECB’s action.

But the question is whether the real economy is feeling the benefits of QE. Last week the Irish Central Bank published figures showing that in the year to July, repayments of loans by companies exceeded drawdowns by €4.1 billion. Repayment of loans/mortgages by households exceeded drawdowns by €2.64 billion. So people continue to save despite almost zero interest rates on deposits. During the year to the end of July 2015 household savings increased by €2.1 billion while savings by businesses increased by €5.4 billion.  Companies and households are extremely focused on paying off debt while at the same time borrowing very little. The picture is similar across the Eurozone – household saving rates in the Eurozone are at 12.8% while household investment rates are below 10%.

This has happened before, most notably during the Great Depression in the United States when high levels of debt cause individuals and companies to pay down debt while hardly anyone borrows or spends at low interest rates.

Quantitative Easing can only really and truly work when banks are lending properly and when households and businesses are borrowing sufficiently to spend. Many people will say that QE is the reason why the US economy rebounded in 2013 and 2014, yet the true catalyst behind the improved economy in the US was due to the huge stimulus package of almost 800 billion dollars which the US government carried out. This pumped money directly into infrastructure, health, education and other incentives to get the country spending. But the US is still in a trap – both households and companies are net savers and have been for a long period.

For Quantitative Easing to work properly, it needs to be mixed with adequate levels of stimulus. Jean-Claude Juncker, the European Commission President has made a positive contribution here by developing a €315 billion Investment Plan for Europe which will work alongside QE. But Member States need to do their bit to get public and private investment going. None more so than Germany whose investment rate is among the lowest in the OECD. Ms. Merkel understandably wants to keep the budget in check, but this is a golden opportunity for a country with strong growth, low unemployment and large budget surpluses to put a serious expansive investment plan in place. Additionally, if it is right that countries in excessive deficit spend less and tax more so as to reduce risks to the Euro area, it must equally be right that countries with a surplus spend more to compensate for reduced economic activity elsewhere in the Euro area.

Ireland is still playing catch up on the investment front following a very difficult bailout period – we are currently third lowest in the EU in terms of investment spending. But as the fastest growing economy in Europe, conditions would seem very favourable for a healthy injection of investment. The government’s capital investment programme, to be published shortly, needs to be really ambitious. IBEC has said that an additional €1 billion should be allocated to infrastructure spending in the next budget which is not far off the mark. This spending would go much further than QE at channelling money into real economy and getting people spending more than saving.

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