With the economy of the European Union becoming more and more stagnant, Mario Draghi, the Head of the European Central Bank, has announced intentions to introduce Quantitative Easing. The plan includes injections worth up to €1.1 trillion, with € 60bn per month until the end of 2016. Before attempting to understand whether or not this policy will be effective, it is necessary to define QE. The theory is as follows: the Central Bank, in this case the European Central Bank, creates money in order to buy bonds from financial institutions. As a result of this, long term interest rates are reduced which therefore leads to a decrease in the cost of borrowing for businesses and individuals. This increase in borrowing allows more money to be spent and also more investment to occur which results in economic growth. Furthermore, there are two distinct types of economic growth which need to be considered; firstly, short term aggregate demand growth which is any change in the following - Consumption, Investment, Government Expenditure, or the extent to which export revenues exceed import costs. Secondly, growth can occur following an improvement in aggregate supply, a term which is harder to define. Aggregate supply can be described as; the total supply of goods and services produced within an economy at a given price level. However, it is perhaps more easily understood as the combination of human, physical and social capital. Human capital measures the skill level and health of all individuals and their ability to reach their productive maximum; physical capital is the totality of factories, transportation systems and machinery which produces more consumer products and, lastly, social capital is the consideration of the ability of institutions to counter corruption and lead to the productive potential of the economy.
 |
| Head of the ECB - Mario Draghi |
Now that terms are understood, let us consider some effects of heightened QE in the EU. Quantitive Easing was first used by the Bank of Japan in the early 2000s and resulted in extreme depreciation of the currency. This is when when the value of one currency falls relative to the value of other international currencies. In other words, a currency becomes cheaper and therefore export volumes tend to augment because foreign buyers now have higher purchasing power. Following currency depreciation, an economy’s balance of trade tends to improve and therefore economic growth occurs. Following the financial crisis in 2007/8, the United States and the UK began to adopt QE policies. It is important to note that Quantitive Easing is a form of monetary policy. QE tends to be considered a last resort to stimulate spending if interest rates are so low that they can not be brought down any further. Economist, John Maynard Keynes described this process as ‘pushing on a piece of string’. By late November 2008, the US Federal Reserve began to purchase $600 billion in mortgage backed securities and by March 2009 the Reserve held $1.75 trillion of bank debt. It was not until the 19th June 2013 that Ben Bernanke, the head of the US Federal Reserve, decided to begin the process of tapering QE. It is difficult to evaluate whether or not QE has been successful in the US. Firstly, there is no debate that the American economy is performing very well. 2014 closed with unemployment figures down to 5.6% compared to a high 9.6% in 2010. However, the extent to which high levels of QE has caused this recent strong economic performance is questionable, as there are many other factors to be considered that may have contributed. Furthermore, the extent to which the success of QE is to replicated in Europe offers further thought and debate.
 |
| Former Head of the US Federal Reserve - Ben Bernanke |
In the context of the European Union QE could potentially cause several economic problems. Firstly, and perhaps most obvious, is the issue of inflationary pressures. When the money supply increases in any economy, so do inflation pressures. Inflation creates its own problems, notably that it causes both negative expectations and low confidence from both internal and external economic agents. For example, if inflationary pressures occur in the EU, in countries such as Greece, this is likely to cause foreign investors to withdraw their money. Politically, the introduction of QE and the resulting inflation is a very sensitive issue in Germany. Hyperinflation in Germany during the years of the 1920s has resulted in an entrenched fear of the economic phenomena. Given Germany’s strong influence on all political and economic matters in the EU, the introduction of QE might be an indication of a shift in power. Furthermore, poor economic performance in Germany over the last year has perhaps resulted in a political willingness from Merkel to work together with the EU members. There appears no doubt that most member countries of the EU desperately need a ‘kick start’ to their economy which QE might offer.
The relationship between economic inequality and QE must be analysed. The theory states that lower interest rates will result in higher borrowing and therefore an increase in consumption and investment. However, there are several assumptions. Firstly, individuals and businesses lack confidence due to the shock of the economic recession in 2007/8 and the resulting austerity. Workers are more fearful for their job security and therefore any increase in their borrowing will be towards keeping a healthy savings level rather than merely purchasing. More importantly, businesses also lack confidence to take risks with their investments. Further, there is currently a lack of investment opportunities for large corporations. As a result of this, they may not spend the money they receive as a result of QE. This refusal to spend and instead merely ‘hoard’ the additional money results in a further rise in inequality. Inequality causes several problems; social, political and economical.
Lastly, the difference between QE in the US and the EU is as follows; in America people are willing to help each other out and there is both factor and labour mobility. Factor and labour mobility means that resources can be easily moved to where needed. For instance, if there was a shortage of jobs in Kentucky, people could easily move to a state where there were job opportunities. Whilst Californians are more likely to agree to help their fellow Americans in the state of New York, members of different EU nations are not. Deep political boundaries exist; due to the recent history of the continent, for instance Germany and Poland do not see eye to eye on most political values. This fact becomes more significant when one appreciates the lack of convergence and similarity in economic progress between different nations in the EU. For instance, policies which will help the current problem in Greece, a debt ridden nation, will not necessarily enhance economic performance in France or Germany. Whilst there is also dissimilarity in economies between states in the US, the willingness of the people to help each other and be mobile counter acts this. Until the EU is united on more than merely monetary policy; and agrees on fundamental political, social and economic principles than any policy will find it difficult to improve the current poor economic performance.
Additional Reading:
