It’s a forgone conclusion in the markets that the European Central Bank will soon roll out a quantitative easing program—buying government bonds with newly printed money. Yesterday’s legal ruling paves the way for no less—a lawyer at the European Court of Justice said that the ECB’s bond-buying program doesn’t run afoul of EU law. But otherwise the subject of the ECB and QE is morass of uncertainty. In fact, it’s fair to say that the outlook for what can be achieved with the next phase of monetary stimulus, and how it will proceed, is a tangled web of unknown unknowns at this point.
The main questions: Will QE revive the Eurozone’s stagnant economy and how will the ECB implement the program? Let’s start with the easier question first—what will QE deliver on the macro front?
The short answer… not much, at least not much by the comparatively high standards of the Fed’s moderately successful QE of recent years. Sure, the Eurozone could use a muscular dose of QE. With headline consumer inflation falling 0.2% on a year-over-year basis through December—far below the ECB’s roughly 2% target–the euro area is a textbook case of an economy in need of a central bank assistance on nipping deflation in the bud. That’s no trivial goal. If the deflationary trend deepens, Europe’s macro challenges will increase beyond the already trouble profile we’ve seen in recent years. Success on this front is essential, and one that QE, assuming it’s designed properly, can deliver… even at this late date. By contrast, expecting QE in Europe to juice growth by any meaningful degree is another matter.
A crucial stumbling block is the already low level of interest rates in Europe. Rolling out QE at this point will have much less impact compared with what could have been achieved several years ago. For instance, consider interest rates. When the Federal Reserve in late-November 2008 announced the first phase of QE—buying up to $600 billion of mortgage-backed securities—the benchmark 10-year Treasury yield was relatively high—in the low-3% range at the time—compared with rates in Europe at the moment (Germany’s 10-year yield is currently around 0.50%). As such, the potential for juicing growth by slashing rates is far less attractive in Europe today vs. the US in late-2008.
