The European Central Bank has been late to try quantitative easing and may find that additional euros cannot buy much relief
We all have the tendency to rely on the tried and true tricks we have found helpful in the past even when their usefulness has faded. This also seems true of central banks who have come to rely on quantitative easing even though its effects show signs of fading. Even the initial boost provided by the first attempts at quantitative easing was limited and the situation has deteriorated amid its continued application. As the last major central bank to give it a go, the European Central Bank will not get much return from any extra cash.
Why more is not always more
Economist should know that repeating the same policies does not always work considering a well-used idea in economic theory known as diminishing returns. This concept refers to the way in which more of the same often comes with fewer additional benefits. Economists use this to describe why the second plate of ice cream does not taste as good as the first or why one more cook in a crowded kitchen doesn’t necessarily improve the food.
Printing more money, which is the basis for quantitative easing, sounds like a sure-fire way to generate economic growth but any economy can only handle so much money. The world is already awash with cash even before central banks started with quantitative easing. This means that every additional dollar, euro, or pound printed as part of quantitative easing is being added to an already substantial pile of cash. With money already being hoarded by many companies and governments not wanting to spend more cash, there is not much use for any more.
No need for more
With the meagre effects of quantitative easing on the wane, it was the earlier versions that would have generated the most bang for each additional buck. It was the Federal Reserve and the Bank of England that tried out the first rounds of quantitative easing – the goal was to push investors away from government bonds to more risky investments such as corporate bonds or stocks. The hope was that this would help provide companies with easier access to cash and to perk up investors by boosting share prices.
Not all of the extra dollars and pounds would have stayed local but also headed overseas to find places to earn more money. This meant that the effects of quantitative easing would have been felt far beyond the countries where the cash was originally coming from. It has been helpful in places such as Portugal and Spain with overseas investors buying bonds issued by the Portuguese and Spanish governments as worries about Europe eased.
With the effects of quantitative easing having already spilled across international borders, there is not much more to be gained from even more cash. As such, the additional euros coming out of the European Central Bank following the recent launch of quantitative easing in Europe may not amount to much. Any further action may also be limited as the saga over whether or not to implement quantitative easing has highlighted how the European Central Bank only has limited room for manoeuvre when running in opposition to Germany. Now, more than ever, it is time to try something new.