Ifo Viewpoint No. 157: Quantitative Teasing
Munich, 17 October 2014
In spring 2014 Quantitative Easing became the new magic word of the European Central Bank (ECB). It alluded to the programme the ECB had prepared behind closed doors to buy private and public securities to prop up uncompetitive economies and their banks. However, in view of the significant opposition it encountered, the ECB Council put the programme temporarily on hold, and came up with a programme of purchasing ABS paper and covered bonds instead. The purchases are to begin in October 2014. A number of central banks resisted this plan, among them the Bundesbank. Nevertheless, a comfortable majority in the ECB Council was in favour, where all countries, regardless of size, have the same vote. ECB President Mario Draghi has indicated that he would like to expand the ECB’s balance sheet by about one trillion euros. Given that the TLTRO program has not found much demand among the banks, it is likely that most of the balance sheet expansion will come through asset purchases.
When the ECB announces large programmes, the taxpayers had better beware. Behind such programmes often lurks a bail-out activity to rescue teetering banks or countries and their international creditors. So it was with the Securities Markets Programme (SMP), under which 223 billion euros in government bonds of the crisis-stricken countries were bought, or with the Outright Monetary Transactions (OMT), with which the ECB announced that, if necessary, it would buy such bonds in the future without limit. The special credit given to commercial banks in southern Europe through the money-printing press by way of reducing the collateral standards for ECB credits, which is measured by the so-called Target balances, also turned out to be a gigantic fiscal rescue programme rather than ordinary monetary policy.
The looming losses resulting from such policy measures will be shifted onto the taxpayers, who will bear them in the form of reduced distribution of central bank profits to the respective treasuries, of new contributions to rescue packages that the parliaments will have to eventually put together in order to relieve the load on the ECB, or of losses from outright fiscal transfers that will eventually be necessary to endow the debtor countries with sufficient funds to repay their debts. The ECB’s overstepping of its mandate prompted the German Constitutional Court in February to charge it with abuse of power.
The Court should now submit the new asset purchasing programme of the ECB to critical scrutiny, since, contrary to all assurances being proffered, it again amounts to a fiscal rescue operation that bears little resemblance to monetary policy. It is in fact economic policy, which the Maastricht Treaty explicitly excludes from the ECB’s mandate. Its mandate, given that the Eurozone is not a state, is much more limited than that of Anglo-Saxon central banks.
When the inflationary bubble created by the euro burst, it tore huge holes in the balance sheets of European banks. The public has been kept in the dark about this by dint of some creative accounting, but the truth cannot be kept under wraps much longer. The stress tests slated for this year for the new Banking Union could lead to disaster if no measures are undertaken to safeguard the bank assets. The purchase of risky securities with freshly printed money appears to many as the only possible solution.
It would have been possible also to choose to recapitalise the banks with money from the ESM rescue fund. But in view of the hefty opposition this proposal encountered in the European Parliament, the ECB Council decided to take matters into its hands. Monetary policy reasons can always be dug up, and afterwards it would simply be a matter of convincing the parliaments to step in with fiscal rescue measures.
The ECB wants to act now because it is itself in peril as a result of having accepted collateral of ever poorer quality for the refinancing credit it granted. It accepted bonds rated as non-investment by the rating agencies and untraded ABS instruments that the banks concocted themselves using their junk paper. Half of the Eurosystem’s stock of central bank money turned in this way into Target credit for the banks of the distressed countries.
It is likely that the new asset purchasing programme will come together with an expansion not only of the ECB's balance sheet but also of the Eurozone’s monetary base, as demanded by Manuel Valls, the new French Prime Minister. Valls hopes that this will lead to a fall in the value of the euro and thus provide a boost to his country’s anaemic exports.
Actually, Valls is right. The promise of investor protection in the form of the OMT programme made the bonds of the southern European countries attractive again to non-EU investors, leading to a noticeable appreciation of the euro. However, the new promise of actual purchases has the opposite effect, since such purchases will crowd out the non-EU investors, who will repatriate their money and thus exert downward pressure on the euro, a development that investors are already anticipating today.
Professor of Economics and Public Finance
President of the Ifo Institute
Published in similar form in German under the title “Neues Schutzversprechen”, Wirtschaftswoche, No. 20, 12 May 2014, p. 37.