25rd January 2015

The European Central Bank's announcement on Quantitative easing

It is probably the wrong tool for the job

There has been much comment on the European Central Bank's announcement on Quantitative easing (QE) and I will add my two-penneth. Whilst this is seen as a last ditch attempt to save the Eurozone it is probably the wrong tool for the job. QE was used by the US and UK central banks to provide liquidity to the financial system following the 2008/9 crisis and for this it can be considered successful. But bank liquidity is not a problem for Euro zone banks at this moment so other rationales must apply. One is to pump more money into the European economies to increase both inflation and lending. But again there have previous schemes to expand lending and there is no reason why this should succeed where they have not. As for general inflation the experience of both the US and UK does not bear this out. Rather the money has been invested in assets leading to inflation in their prices and the inequality that some complain of. This is understandable, firstly when there is little growth and inflation remains low, investment in the real economy is risky as opposed to assets that hold their value even in the toughest of times. Secondly as explained elsewhere on this web site the level of interest rates are closely tied in with those of inflation. So the specific purpose of reducing the yield on government bonds will have the opposite effect and maintain low inflation. The one positive influence of QE will be the easing on government borrowing finances. But this will only benefit these lacklustre economies if it leads to increased public spending. This is not a given as Germany seeks structural changes to accompany the money printing. In all likelihood QE will deepen the Eurozone's problems rather than alleviate them. A practicable solution would be to give the money directly to its peoples or to increase interest rates and use the money for tax rebates to cover the increased costs incurred.

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