Me? I believe Quantitative Easing (QE) is at worst a placebo; and the record on the efficacy of placebos is impressive enough to make even their prescription worthwhile in many cases.
What I’m highlighting this week is not an academic paper but a telling report from the European Central Bank (ECB) that may go some way to explaining why Super Mario took the QE plunge last month and, of more practical use, why it stands a good chance of being effective.
I’ve been reading a lot about QE recently as, to be honest, I didn’t understand it. What I’ve been delighted to learn is that nobody else does either, really. The process seems to have originated in Japan but by 2001 the Bank of Japan had come to the conclusion that it didn’t work (http://www.imes.boj.or.jp/english/publication/mes/2001/me19-1-4.pdf ). Strange then they decided to give it another go beginning April 2013?
In America opinions remain divided with the only conclusion to have formed a consensus is that it has reduced interest rates prevailing in the market, most especially in the longer end of the maturity spectrum. Whether that’s led to lower unemployment, a stronger dollar, higher home prices or is the root of a bull market for US stocks still remain issues of contention.
The good thing about QE is it’s self correcting. Governments cannot buy bonds indefinitely and those bonds will all mature. Funny-money may be used initially but the repayment of bonds is a very real obligation of their issuers. So, at the end of the day, it’s a temporary liquidity provision mechanism. No more scary than bill buying at the short end of the market that central banks have done for years but differentiated in terms of the time over which it operates.
The key therefore is to make sure that if you’re providing liquidity there’s going to be a demand for it. It’s most likely the early Japanese experience was because the economy was so moribund that they found themselves in the well understood Keynsian liquidity-trap? Thus, like most economic policy, it’s efficacy will depend on the individual circumstances prevailing at the time.
To the point and Europe. The ECB produces a quarterly report ‘The Euro Area Lending Survey’ and the latest edition was published earlier this month. Mr. Draghi would have been well aware of it’s contents before throwing the QE switch. What the report suggests is that across Europe willingness and ability to lend is rising whilst loan demand is increasing. Demand for credit is especially manifest in the areas of housing and capital investment and, if the survey proves correct (to remind, it’s about intention not action), an extra shot of liquidity is just what the patient can be expected to respond well to at this stage in the cycle.
[You can access the report at https://www.ecb.europa.eu/stats/pdf/blssurvey_201501.pdf?7a1bddab03050b0b033cc26a03eef16c. A flick through the summary should suffice for most.]
The bottom line is that a global economic recovery, led by the US for sure, remains underway and the actions of the ECB last month are in no way likely to retard it’s progress. In fact, in time, we may come to see their action as being that of pushing on an open door.
Happy Sunday indeed!