What will European QE look like? And will it work?

Claire Jones at the FT reports:

The European Central Bank is set to unveil a programme of mass bond buying next week to save the eurozone from deflation, but has bowed to German pressure to ensure that its taxpayers are not liable for any losses incurred on other countries’ debt.

This is not a surprise.  Alen Mattich had a good Twitter comment:

How could you trust ECB promise to “do whatever it takes” if it doesn’t accept the risk of holding national sov debt on its books?

Guntram B. Wolff has an excellent, detailed analysis, worth reading in full, here is one bit:

So the purely national purchase of national sovereign debt would either leave the private creditors as junior creditors, or the national central bank has to accept negative equity. What would negative equity mean for a central bank? De facto it would mean that the national central bank, that has created euros to buy government debt, would have lost the claim on the government. It would still owe the euros it has created to the rest of the Eurosystem.(4) The Eurosystem could now either ask the national central bank to return that liability, which it is unable to do without a recapitalisation of its government. Or, the Eurosystem could decide to leave the claim standing relative to the national central bank. In that case, the loss made on the sovereign debt would de facto have been transferred to the Eurosystem. In other words, the attempt to leave default risk with the national central bank will have failed.

…Overall, this discussion shows that monetary policy in the monetary union reaches the limits of feasibility if the principle of joint and several liability at the level of the Eurosystem is given up.

An important open issue is whether the ECB could buy Greek bonds, given that they are up for restructuring and (presumably) the Bank cannot voluntarily relieve Greece of any debt (see Wolff’s discussion).  There are plenty of rumors that Greece will indeed be excluded from any QE program, unless you imagine they settle things with the Troika rather more quickly than they are likely to.  Yet a bond-buying program without Hellenic participation doesn’t seem so far from hurling an “eurozone heraus!” painted brick through their front window in the middle of the night.

Overall, shuffling assets and risk profiles between national monetary authorities and national fiscal authorities would seem to accomplish…nothing.  Not buying up the debt of your biggest problem country also seems to accomplish nothing, in fact it is worth than doing nothing.

Here is my 2012 column on how the eurozone needs to agree on who is picking up the check.  They still haven’t agreed!  In the meantime, Grexit is a very real possibility, through deposit flight, no matter how badly Greek citizens may wish their country to stay in.

So, so far I am not so optimistic about this whole eurozone QE business, even though in principle I very much favor the idea.  It is again a case of politics getting in the way of a problem which does indeed have a (partial) economic solution.  The only way it (partially) works is if it (implicitly) bundles debt relief with higher rates of price inflation.  Have a nice day.

Comments

As far as I understand, they have it completly backwards. If the ECB buys government debt from the southern countries and then accepts a complete or partial default, that would constitute a fiscal transfer from north to south, which is exactly what is needed when there is an assymetric demand shock. A bit had hoc, I know, but the situation calls for a little pragmatism.

The Germans know this, which is why they oppose QE. The eurozone is not about European solidarity; it's about enriching Germany at the expense of the south, by reducing their competitiveness from currency devaluing. The EU is working exactly as planned.

Don't forget southern and eastern European governments who wanted a scapegoat for having to introduce overdue economic and institutional reforms they couldn't have forced through their political systems any other way. Much lower and more stable inflation was one side-benefit.

Or haven't you noticed only Marine Le Pen wants here to leave the euro? Even Syriza doesn't want Grexit.

If, unlike Romania, you can't have a German president to clean house, use of German money is the next best thing to keep the bastards in the capital halfway honest.

I don't know if I'd go that far, but I think the Germans need to ultimately recognize that they can't keep laying everything at the Greeks' feet. It takes two to tango; and it takes two to have a dysfunctional currency union. Greece can't do everything themselves because so much of their success involves some variable relative to that of Germany.

I'm not sure I'm following this. Let me put forward a very simple transaction:

1. ECB created 1000 Euros, goes into the market and buys a bond issued by, say, Greece, that matures in 5 years.

Stop right there. In 5 years either Greece will pay off the bond, in which case 1000 Euros will leave the economy and return to the Central Bank, or they won't.

2. At some point, the ECB wishes to have less cash floating around so they try to sell that bond. Because of either fears of a default or just interest rate movements, the bond will only fetch 700 Euros in the market.

So this would appear to be a loss of 300 Euros. But then the ECB just printed the euros out of thin air to begin with so why would German taxpayers have to 'make it up'?

Europeans like to drive

Pushing the gas pedal (monetary)

And the brake (fiscal)

At the same time.

This will go real far.

Japan 2.0

USA 2013.

Monetary offset?

Why does government even bother to issue debt, or even to tax? They can just have the central bank print up whatever money they need.

I have asked myself that question. I suppose because politicians love interfering in things, issuing instructions, punishing people, and so on. Having the central bank print whatever money they need might seem dull by contrast.

A big reason central-bank liabilities circulate as currency in the first place is that the state will accept them in payment of taxes.

That seems a contrived, post-hoc explanation. If the state accepted banana peels in payment of taxes, would that make banana peels the commodity in universal demand?

I know you're trying to make a point with snark, but that is hugely sub-optimal, so people have set up institutions through their governments to achieve a better outcome.

What is the substantive difference between printing money and buying debt with it, and just cutting a check to the borrower?

But that's not the same thing as just printing up money in lieu of taxation or debt. You want to have a system where most of the time, the Treasury has to fund itself with a combination of taxation and debt, and the monetary authority tinkers on the margin to maintain a low and stable-ish inflation rate. This is a system that works pretty well most of the time, but 2008-9 was not one of those times. Financing the gov't through money printing would entail a heckuvalot of hyperinflation, among other problems.

I think (and correct me if I'm wrong) that you believe this is all a fraud, and that the Fed is actually operating a scheme to monetize large amounts of US gov't debt. I don't believe that that is true, and the markets also don't seem to believe that either, as evidenced by the fact that inflation keeps coming in below the Fed's stated target. Perhaps if they started burning the Treasurys, or sinking them to the bottom of the ocean and writing them off, or some such thing, that would be the case, but so far there is no indication that anything like that is occurring.

AG,

There is a good answer to that question that Vickery posed a generation ago.

At some point printing money for government expenditure will result in full employment and at that point, it will start to produce inflation. Inflation beyond some fairly low limit (5%? 10%) has greater dead weight losses than taxation and so becomes an inefficient way of raising revenues. This explains why those who oppose inflation favor taxes the progressive income tax that has low dead-weight losses compared to things like payroll taxes. :)

Again, what's the substantive difference between printing money and buying debt with it and just decreeing a credit to the borrower's account?

Seems like we could just trade value for value, and then fire all the economists and shut down the Fed.

The line about EU states not taking on liabilities for each others' bonds through this QE is of course a phony PR ploy. What it means is that national central banks will be doing the buying, and the government bond assets and euro liabilities created will formally sit on the balance sheets of the NCBs, not directly on the ECB's balance sheet. But that's an economically meaningless distinction. Euros are joint liabilities of the whole European system of central banks, regardless.

I will continue to predict disinflation/low inflation with a falling average rate as I did here:

http://informationtransfereconomics.blogspot.com/2015/01/eurozone-deflation.html

... and basically since November 2013.

Also, QE does nothing to the price level as was shown by the cleanest experiment ever in economics:

http://informationtransfereconomics.blogspot.com/2014/11/quantitative-easing-cleanest-experiment.html

Since the default risk of any bond of a government that is in foreign currency -- every country in the Euro by definition -- is greater than zero, ECB cannot buy any sovereign debt at all. This does not sound like "QE" at all. Do these guys specialize in non-executed/executable policies? First they had an inflation target that they have refused to hit and now a QE program that cannot work by design

If the problem is low inflation, why are they buying sovereign bonds, instead of other less contentious assets? US QE involves purchase of mortgage-backed securities for example.

What less contentious debt? Spanish mortgages? Italian bank debt?

Why would anybody hurl a brick saying "Eurozone, come out", in the middle of the night at that?

I read these articles and even those they link to and still don't get the concerns. In a fiat currency union, a central bank can't default, except on liabilities in a different currency, and assuming no odd governance mechanism that bars it from printing money to satisfy its own same-currency debts, if any. Yes, it may bear the "risk of defsult" of a sovereign bond it holds, but unlike a private fin institution, it can create unlimited amounts of its own currency, so the default doesn't lead to anything directly. The link that contends central banks in a fiat currency will need recapitalization by their fisc makes no sense.

There are all kinds of other objections to aggressive QE as a recurring policy, in particular that it can legitimize fiscal profligacy and the two in combination will produce runaway inflation. But the argument in these links doesn't make sense.

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