BLOGSPOT: IS QE THE MIRACLE WAND FOR EUROPEAN ISSUES? AN ASSESSMENT
A resilient but weak growth in Europe: Looking for new strategies
Although the IMF downgraded its global growth forecast for 2015 from 3.5% to 3.1%—driven by a downward revision for China and other emerging markets, advanced economies are experiencing their best performance since 2010 (IMF WEO).
Resilient Growth in the Euro area. In the Euro Area, GDP growth reached 1.5% during the second quarter of 2015 (Eurostat), driven by domestic demand and showing resilience (Morgan Stanley). The recovery is uneven with stronger than expected growth in Italy and especially in Ireland and Spain offsetting weaker than expected growth in Germany (IMF). Yet, downside risks are increasing in the Euro Area. Arising from a growing fiscal sustainability concern, insufficient fiscal consolidation in the United States and Japan, emerging markets slowdown and oil supply risks, downside risks could undermine Euro area growth compared to the WEO forecasts (IMF).
The Need for a common growth strategy. European GDP per capita is still below its pre-global financial crisis level and sovereign debt is high. Hanz-Helmut Kotz, Eric Labaye and Sven Smith in Project Syndicate call for a European growth strategy, with both supply and demand-side reforms. The context is favorable thanks to a low oil price, greater exchange rate competitiveness and an expansionary monetary policy.
The UK sideshow: the austerity debate again. The Office National Statistics revised its estimate of GDP growth upward. According to Robert Petson (BBC news), the 2010 austerity in UK allowed a conceivable economic recovery. For Simon Wren Lewis (Mainly Macro), this is “nonsense,” reflected in the weak UK economic performance in 2013. Paul Krugman and Ben Shu in The Independent support this view and argue that the UK recovery would have been even quicker without fiscal austerity.
QE in the Eurozone: What is the six-month assessment?
QE implementation on track. Alberto Gallo (RBS Silver Bullet) writes that the ECB is on track to implement its asset purchase program, with a monthly average purchase of €60.5bn (see also Alessandro Speciale (Bloomberg business). It announced a trial program for three central banks to conduct reverse auctions for purchases of sovereign bonds.
An assessment of the impact of QE. Gallo (RBS Silver Bullet) reviews the various channels through which QE has worked:
A (short-lived) compression of sovereign yields and risk premia in financial assets—the short start of bond markets in 2015 dissipated since May.
Lower lending rates for corporate, across the Eurozone, with the core-periphery gap shrinking—with a small reversal in August.
A pick-up in growth in money supply but with weak lending volumes—as banks are still not increasing corporate lending (ECB data).
Inflation is back in negative territory and inflation expectations have continued to decline.
Is the Eurozone facing deflation? Headline inflation, which was close to 0 percent for six months, read at -0,1 percent in September. For Eurointelligence, given that the decrease in oil prices (down 8.9 percent yoy) is responsible for the low headline inflation rate (FTALPHAVILLE), the negative inflation rate is not deflation. Core inflation has remained unchanged since May, close to 0—raising doubts about the effectiveness of QE (Eurointelligence). Ferdinando Giugliano and James Shotter (FTALPHAVILLE) report that economists are generally encouraged by the resilience of core inflation, despite an increasingly uncertain outlook.
What is behind the lack of effectiveness? Analysts are looking for the lack in effectiveness in a number of design faults:
Delayed implementation—as highlighted in FTALPHAVILLE, it took six years for the ECB to follow the lead of its peers and launch a QE program in the Eurozone, too late according to OpenEurope. Charles Wyplosz (Telos) reflects on the example of Japan, where delays have been associated with slow results, with the euro area facing similar issues due to policy conflicts between member countries.
A different economic context—when the US implemented QE, borrowing costs were above 4 percent, they are close to 0 percent in Europe today. For OpenEurope, very limited benefits coupled with high legal and political costs will render QE ineffective on the Eurozone’s economy. Weak economic performance in Q2 2015 also affected the effectiveness of QE.
Structural factors—identified by Gallo (RBS Silver Bullet): weak banks and past debt overhangs constraining lending; unequal distribution of the QE wealth-effect (ECB paper); structural rigidities preventing a return in investment (MIT research).
According to Eurointelligence, a “Japanese-style” crisis is a risk, with a negative interaction between income, spending and depressed expectations, leading to further deflation. FTALPHAVILLE, however, reminds us that nominal growth in Europe has remained positive at a steady pace of 2 per cent, compared to a 20-year stagnation in Japan.
Another measure of the effectiveness of QE is the exchange rate. FTALPHAVILLE points out that QE failed at preventing the single currency from strengthening since last April. Giugliano and Shotter (FTALPHAVILLE) are concerned about the resilience of the euro, which built up strength against the dollar after the FED delayed its first increase in interest rates since the crisis. Further, David Keohane (FTALPHAVILLE) discards the exchange rate channel as effective against deflation, a view supported by Stephen King (hat-tip Eurointelligence).
This discussion supports a transition from monetary policies to fiscal policies. QE alone is not capable of stimulating sufficient demand in a world where other major economies are facing the same challenges (Project Syndicate). Adair Turner reports (Project Syndicate) that the effectiveness of QE’s demand stimulation in domestic markets remains very uncertain.
Why the ECB might extend the QE program… Options behind QE are limited for Mario Draghi (OpenEurope), making an extension of the program increasingly likely, especially in light of the continued slippage in inflation expectations—as suggested recently by Ben Bernanke. However, M. Del Carpio, quoted in FTALPHAVILLE, emphasizes that the ECB is likely to wait until December, when new staff forecasts will be released, before taking any further step. This is also the view of Standard & Poor's as mentioned in Deutsche Börse Group. RBS economists (The Silver Bullet) are worried that the longer the Eurozone remains dependent on QE, the harder it becomes for the ECB to unwind its monetary stimulus—with a risk of being trapped in QE.
