Monday, 1 September 2014

Quantitative Easing – Waiting while Europe Sinks

As Europe cries out for more action against deflation, the central bank must wait until the situation gets even worse

It would be strange to hold off saving people in a sinking ship until the ship is just about to go under, but this is how monetary policy works in Europe.  The situation in European grows continues to get worse as economic growth stagnates and deflation sets in.  Yet, the central bank cannot help, as it is hamstrung by politics, and must hold off until the cost of inaction is too high.  This means that Europe will have to take on a lot of water until a rescue package can eventually be put in place. 

Politics muddies the water

Monetary policy is tough enough in one country, let along for the 18 countries which use the euro.  The European Central Bank has acted boldly when given the chance.  It took a stand in 2012 stating that it was willing to do “whatever it takes” to save the Eurozone.  This was the lifeboat that saved Europe from collapse at a time when national governments were absorbed riding out wave after waves of turmoil.  But the European Central Bank was only free to jump in once it seemed as if Greece and other countries were about to let go of the euro. 

Despite a temporary reprieve, the economies of Europe have been like a listless ship with leaks.  Reforms have been put off in the hope that the worst is over and economic growth would return without any further encouragement.  Yet it is not a surprise that Europe is close to being sunk again but this time in slow motion.  The problem is the rules and regulations that get in the way of more efficient ways of doing business.  Economic growth cannot be seen as a given and government policies must allow resources to move to more productive uses.   

Such reforms tend to be unpopular as the costs are borne upfront while it takes time for the benefits to show.  So politicians in Europe have put off these measures as pleasing voters is proving tough enough as it is.  Instead, it has been easier to blame others and wait in the hope that economic growth will return.  This wait-and-see approach relies on the central bank to help out with the economy but this is beyond what the European Central Bank can achieve.

The politics behind the European Central Bank is made even more difficult in dealing due to some countries floundering more than others.  Amid all of the concerns about deflation, it is already a fact of life in some countries such as Greece and Spain.  Yet, even Europe as a whole is edging closer to deflation which is typically the symptom of a sluggish economy.  The fear is that deflation will create its own problems if falling prices prompt consumers to hold of spending in the hope for cheaper goods in the future.

Waiting until things get worse

The central bank has already responded to the threat of deflation through a policy of negative interest rates.  Quantitative easing, which has already been used (with limited success) in other countries, is the obvious choice to ramp up monetary policy.  This option has been kept off the table due to its potential to cause inflation which raises hackles among Germans.  Since any measures by the central bank could be deemed to be inflationary, Germany has used its influence to restrict the ability of the central bank to act. 

Yet, even the Germans will eventually have to see deflation as the greater threat.  But, at the same time, it is tough to gauge when too little inflation (or too much deflation) will be enough for a change of tack.  Germany has stuck to its guns since the outbreak of the Eurozone backed by an economy which had until recently remained buoyant.  So Europe is likely to get quantitative easing sometime (soon) and hopefully before the Eurozone is too far under water.


  1. Hi,

    1. I think that the idea people will wait to buy stuff because it will be cheaper in the future is simply not true except for asset classes such as stocks and houses. We are now used to seeing next year's models coming out with either more advanced features or cheaper.

    2. Deflation in consumer goods and daily purchases puts more money in the pockets of consumers. What is the point of technological improvements if we don't get more for our money?

    3. QE ONLY props up asset prices such as bonds, property and stocks. None of that helps the consumer, but does put more money into the pockets of the already wealthy and supports the financial system.

    4. On a wave of cheap Euro interest, the Spanish, Greeks, Italians and French rushed to give themselves a standard of living, salaries and benefits well above their global productivity and competitive level. All based on the credit rating of the Germans.

    Either the profligate lot leave the Euro and experience a painful loss in purchasing power of their respective currencies, or they undergo a painful deflation in wages and benefits. In any way they there is a lot of pain coming their way. The Germans will certainly not leave the Euro, as it is valued too low for their awesome efficiency and productivity.

    5. I am honestly in despair at the constant calls for the Central Bank to "do something". It is not the Central Bank's responsibility to do any more. They have managed to keep the financial system running and reduced the interest rates to zilch.

    The blasted politicians have to stop whining, moaning and slithering around. They have to take responsibility and apply unpopular fiscal policies to return the standard of living to a level they actually deserve based on world productivity. Which in the case of Greece is somewhere around the level of Cambodia, Spain we can compare with Thailand and Italy with maybe Taiwan.

    Just because the countries are in Europe does NOT mean they should be enjoying living standards at the level of Germany, Sweden, Norway and Denmark.

    1. Thanks for your comments.

      I agree with a lot of what you have to say regarding deflation and quantitative easing. These are topics that I have already written on many times on this blog (please have a look back at past postings) so I did not want to dwell too much on my doubts on economic ideas on both.

      I also agree that monetary policy is expected to pick up too much of the slack. But it would be a tough sell for politicians in Greece to convince Greeks to live like Cambodians considering the prosperity they have enjoyed up to now.

      The bigger picture is one of a declining West against an emerging East and such trends in history often bring chaos and infighting among the loser which is what we are seeing at the moment. Not a pretty sight but Europe was never meant to rule the world forever.

    2. Hi, nice to get a reply.

      It is only since the introduction of the Euro that the Greeks suddenly found themselves able to borrow cheaply and live it up, without any perceptible increase corresponding productivity. Previously they had double figure interest rates, a constantly declining currency and high inflation.

      Now the bills have to be paid. And it will be painful for most, but not the handful of extremely wealthy Greeks.

      I am completely in agreement with you about the swing from the west to the east. The US with its USD still ruling world trade is making a bit of a comeback this month, but the long term means certainly more wealth in the hands of the Asians and less in the West.

    3. It is nice to get a reply to a reply.

      The Greeks did get carried away with too much cheap money but there were also investors willing to offer Greece loans on similar terms to the Germans. I agree that unfortunately the Greek people will end up paying the price but investors should also be sharing some of the burden.