The scale of Quantitative Easing does not matter – it’s how you use it
Today the ECB has finally announced a reduction of its QE programme for 2018. Now it’s time to talk about how to improve its quality.
The European Central Bank announced today that it will downsize its quantitative easing programme from €60 billion to €30 billion per month starting in January 2018 while extending its duration until September 2018.
In our view, the ECB’s announcement was largely expected, and makes some sense. After having injected 2 trillion euros into financial markets for the past three years, it is fair to say that quantitative easing has delivered small and diminishing returns, especially in contrast with the many side-effects of the ECB's policies. There is little evidence that it has effectively moved the ECB closer to its inflation target, in contrast with other external factors such as energy prices.
However, the ECB is also right to recognise that we are far from seeing a sustained and durable recovery. In fact quite the opposite: growth is hindered by private and public over-indebtedness which is the legacy of an unresolved and poorly managed euro crisis. In that sense, the ECB is right to pursue its monetary accommodation, although in its current form QE and negative interest rates are a sub-optimal response.
The QE programme is delivering diminishing marginal returns. The more the ECB does QE, the less effect it produces. Through that lens, the whole conversation about QE tapering is, in our view, largely overblown if not completely secondary. Size does not matter so much as the quality of the design of the programme.
Currently the ECB mainly buys sovereign debt (1,800 bn), but also corporate bonds (120bn) and asset-backed securities (250bn). But the ECB’s approach is blind to whether the money injected through the asset purchases “trickles down” to the real economy.
For example, the ECB has expressly said that it cares very little as to whether supporting Nestlé’s shareholders or providing cheap funding to gambling companies such as Novomatic does help the economy or not. Yet it does not take an economist to understand that injecting money where there is already too much of it does not help much. Similarly the ECB provides no incentive for governments to issue bonds for investments as opposed to general spending.
Moving from quantity to quality
That the ECB made no announcement today about the future composition of the QE programme is noteworthy. Mario Draghi hinted at the fact that this will be the focus of the next meeting of the Governing Council of the ECB in December. It is high time to open up a larger conversation about this.
There are two ways the ECB can make progress in improving the design of the quantitative easing programme.
We have consistently made the argument that the Corporate Sector QE programme is a counter-productive, climate-unfriendly and unpopular approach. The ECB should seek to revamp this programme entirely, moving away from buying corporate bonds from carbon-intensive industries to sustainable, long overdue public and private investments.
For example, such a programme could focus on public investments linked with energy transition, a priority of the European Union that scarcely needs demonstrating. Public investment in renewable energy and energy efficiency would not only create a huge number of jobs, but it would also reduce Europe’s energy dependency on oil producers, hence consolidating our trade surplus. But the main point of course, is that it would ultimately create new economic activity which would in turn push the ECB closer to its inflation target. Mario Draghi recently confirmed that the ECB could in principle support actions aiming at supporting the environmental goals of the EU. Now it has to deliver.
Secondly, the ECB should extend the maturity eligibility rules of the public bonds it buys in order to create more incentives for governments to issue long term, low-interest bonds, hence creating momentum for governments to plan other long-term investments projects. For example, the ECB could extend the maturity to up to 50 years or even accept perpetual bonds (to a certain limit), under the condition that those bonds are clearly investment project-based.
A window of opportunity for Member States
Naturally, supporting investment is not just a job for the ECB, which cannot purchase investments-linked bonds if those do not exist in the first place. Member states should be much more opportunistic than they are, and not listen too much to Draghi’s obsessing over “fiscal space” and “fiscal consolidation”, when there is in fact a near-unanimous consensus everywhere else about the need for fiscal stimulus.
The EU Commission could help too, by announcing a special waiver in the Maastricht rules (the 3% deficit limit) for, say, one year, in order to create further incentives for governments to invest now and until QE ends.
We have consistently argued that QE wasn’t the right response to the crisis. But now that it’s still around for at least another year or so, EU countries had better make the best out of it. There is a unanimous consensus that growth is slow because of the lack of investment. If this is true, we have no excuse not to do something about it. If we don’t use the extremely favorable circumstances for investing now, it will be even harder to do so when interest rates rise again.