By Christine Lee
The European Central Bank announced Thursday that it will create new money to buy €1.1 trillion ($1.3 trillion) of government debt beginning in March, a policy known as quantitative easing, or QE. The ECB will reassess their policy in September.
“The risks surrounding the economic outlook for the euro area remain on the downside, but should have diminished after today’s monetary policy decisions and the continued fall in oil prices over recent weeks,” said ECB President Mario Draghi.
It has long been speculated that the ECB would implement QE to simulate the eurozone’s lagging economy and prevent deflation, or falling prices. Deflation can be interpreted as a symptom of economic weakness that has the effect of lowering prices, incomes and ultimately government tax revenues. Economists fear it could plunge the eurozone into another debt crisis.
“There is a clear danger of a more sustained period of deflation which would destroy peripheral countries’ debt consolidation efforts and could cause market concerns to once again spread from Greece,” said Jonathan Loynes, chief European economist at Capital Economics.
Inflation rose by 0.2 percent in December, far from the ECB’s target of below, but close to, 2 percent.
Traditional economic maneuvers to stimulate growth have been exhausted. The ECB’s interest rates are close to zero, lending rates to commercial banks is a paltry 0.05 percent.
The ECB plans to buy up huge amounts of government bonds in such volume as to have the effect of raising their price and lowering their return. That lowered return is essentially an interest rate. The theory is that quantitative easing will influence interest rates throughout the economy to go down and encourage commercial borrowing and lending. That increased demand is theoretically supposed to raise inflation and stimulate growth.
“Today’s measures will decisively underpin the firm anchoring of medium and long-term inflation expectations,” said Draghi. “The sizeable increase in our balance sheet will further ease the monetary stance. In particular, financing conditions for firms and households in the euro area will continue to improve.”
QE has been implemented in the US, UK and Japan under similar circumstances where central banks faced economic crisis and were unable to stimulate the economy through standard mechanisms, like lowering interest rates that had already reached rock bottom. It’s debatable whether the policy has worked. Critics warn the risky policy devalues currency and can inflate prices uncontrollably. The euro went down 0.7 percent to $1.15 following Thursday’s announcement.
Years after QE was implemented in the US in 2008, critics wrote an open letter to Federal Reserve Chairman Ben Bernanke that was published by the Wall Street Journal.
“We disagree with the view that inflation needs to be pushed higher, and worry that another round of asset purchases, with interest rates still near zero over a year into the recovery, will distort financial markets and greatly complicate future Fed efforts to normalize monetary policy,” wrote a group of US economists, investors and political strategists.
Critics argue that spending cuts, tax reforms and changes in regulatory policy are healthier options to improve the economy. QE is regarded as a superficial quick fix to a broader economic problem.
According to the BBC’s Economics Editor Robert Peston, they’re “painkillers to an economy that needs rather more radical structural treatment.”