December 11, 2016    5 minute read

Quantitative Easing: How Mario Draghi Is Saving Europe

Steering The Ship    December 11, 2016    5 minute read

Quantitative Easing: How Mario Draghi Is Saving Europe

On December 8th, the European Central Bank (ECB) decided to extend quantitative easing (QE) until December 2017 “or beyond, where necessary”. Mario Draghi, the third president of the ECB, said that the rhythm of the quantitative easing debt purchasing would remain stable at €80bn a month until March. From April 2017 until December 2017 purchases will continue at a rate of €60bn per month.

But, he also added, “if conditions require it, the ECB will increase the program in terms of size and/or duration”. The ECB also left the interest rates unchanged: the main rate remains at a record low of 0.00%, the rate on bank deposits at -0.40% and the marginal lending facility at 0.25%.

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What Exactly Is QE?

QE is a plan for the purchase of government and other types of bonds from banks to inject “new” money into the real economy, to stimulate banks lending to businesses and to try to make inflation rise towards the 2% target.

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To have money to support their economies, their services and their activities, states issue titles that can be purchased by citizens and businesses, including banks. Simplifying: periodically, a country offers titles that cost “X” with a deadline, and agrees to return the money to those who bought those titles by adding a percentage of interest when they have expired. Those who buy the securities may not get back the money invested plus interests until they are expired, but it is possible to sell them on the market either to get some money from it or not to lose.

In practice, it offers banks the opportunity to buy back the securities, usually on favourable terms, hoping that with the money obtained from selling the titles will make it easier for businesses and citizens to access credit. Putting more money into circulation with operations such as QE the value of money is reduced, and therefore prices rise.

The Likely Scenario

This is why inflation rises. This is something generally perceived as negative, because of the prices increase, but central banks are well aware that even a minimum inflation is positive. Today for the EU the closer and more dangerous scenario is definitely deflation rather than inflation.

According to several economists, one of the most effective solutions to avoid deflation is precisely QE. So, a weak currency and low inflation, together, should have some beneficial effects on the real economy while also increasing, hopefully, the employment rate.

The positive effect of bringing Europe out of deflation by increasing inflation to 2%, considered the optimum by the ECB, may still be risky. The prices may start to rise rapidly and suddenly, with the risk of high inflation. To date, however, it is widely believed among economists that this scenario can not occur in the medium term and that there are no particular risks.

The Fed Paving The Way

It is to be noted that QE was not applied for the first time in Europe. In fact, it had already been used by the Federal Reserve, which ordered the purchase of securities for a total of $40bn per month until further notice (or until the US economic growth can be said to be “sustainable”).

The UK’s program is called QE3 (since it is the third program of this type) and the Bank of England set a goal of £375bn of purchases, while the Bank of Japan has expanded its program, to 91 trillion yen.

What Comes Next

Many said that this politics could not go on forever, but as of right now it is showing no signs of stopping, and it probably will not for some time. The outlook for price developments, moreover, are not reassuring. The staff projections point to inflation of + 1.7% on average in 2019.

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The tapering is a reduction of the purchase securities. The term tapering is not to be confused with the “tightening” that indicates a narrowing of monetary policy conditions, typical of periods when the economy performs well and does not need stimulation in the form of monetary policy. The two terms are not to be confused because they are not mutually exclusive.

Conclusion

As Bloomberg reported: “While policy makers including Draghi have said that they’ll eventually return to a more conventional monetary stance, they’ve also pledged to do what’s needed to reach their inflation goal”.

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So it is therefore not a quantitative easing without an end date, but it looks like it. After all Mario Draghi is there for a reason, and everyone should be thankful because as the New York Times once reported:

“Mario Draghi is as Andrea Pirlo. An extraordinary director with a vision of 360 degrees game: Never in a hurry, always sure, master of the short passage and verticalization, ruin of Germany, a playmaker that hits the target accurately.”

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