More ECB QE will not stop the Coronacrisis

2020-03-21

On March 19, 2020 the European Central Bank announced a new round of asset purchases (Quantitative Easing or QE) that are specifically intended as a response to the economic downturn caused by the coronavirus pandemic. From the announcement:

[…] the ECB’s Governing Council announced on Wednesday a new Pandemic Emergency Purchase Programme with an envelope of €750 billion until the end of the year, in addition to the €120 billion we decided on 12 March. Together this amounts to 7.3% of euro area GDP.

[…]

We are making available up to €3 trillion in liquidity through our refinancing operations, including at the lowest interest rate we have ever offered, -0.75%. Offering funds below our deposit facility rate allows us to amplify the stimulus from negative rates and channel it directly to those who can benefit most. European banking supervisors have also freed up an estimated €120 billion of extra bank capital, which can support considerable lending capacity by euro area banks.

While the ECB’s response signals an eagerness to cope with the unique challenges the euro area faces, it suffers from a fundamental flaw in its approach to crisis management: it seeks to stem an insolvency crisis by means of expanded liquidity. This is the same misreading of the situation that (i) amplified the euro crisis during the previous ~10 years, and (ii) forced the ECB to engage in de facto fiscal policy that evidently fails in its stated end of boosting inflation to the desired levels.

To remind ourselves: QE is deemed necessary to fill in a void that is left behind by the concerted cuts in aggregate demand imposed by euro area Member States (simultaneous austerity). When spending collapses, the pressure on longer-term inflation rates is downward. Such a trend discourages investments, as persistent disinflation or outright deflation will entail losses while creating an environment of uncertainty and low expectations (i.e. more potential losses). Meanwhile, the ECB is mandated to preserve price stability, which the institution itself has quantified as a rate that is below but close to 2% over the medium-term. I have analysed this latter notion, and its concomitant issues, in my ~4000-word essay from 2017-04-02 on ECB independence: concept, scope, and implications.

The idea of QE is to provide sufficient capital to large corporations, typically financial institutions, in the hope that the money will trickle down to the real economy. Such a phenomenon should eventually be reflected in the inflation rate which, despite the trillions in asset purchases, remains persistently below the ECB’s medium-term target.

QE cannot guarantee an upward inflationary trend, ceteris paribus, because asset holders find it expedient to use their newfound resources to invest in luxury goods instead of directing funds to households and businesses. The new trillions never reach the real economy: they are used in speculative endeavours that are not tracked by the Harmonised Index of Consumer Prices (HICP), such as lucrative contracts for footballers (prices in the European football industry have been exorbitant in recent years), yachts, paintings of dubious aesthetic value that are auctioned for ridiculous sums, etc.

Put differently, QE offers nothing but the impression of a return to normality. It actually aggrandises debts and increases systemic risk, whose extent will only be fully revealed in the next financial crisis.

The fact of the matter is that the euro area never fully recovered from the previous crisis. The feeble positive signs where just a reflection of heightened ECB activism, rather than an indication of strong fundamentals. To use pertinent medical language, if you live off of supplements, you are dealing with an underlying health issue.

More QE means more of the same package of measures that has clearly failed to boost aggregate demand and put inflation rates in line with the ECB target. In an insolvency crisis no amount of liquidity will suffice to arrest the downfall and bring things back on track.

What is now needed is an altogether new mindset that will break free from the ideological constraints that have prevented European policy-makers from rational policy action. We need a genuinely unconventional response from the ECB and the Member States (coordinated via the Eurogroup, European Council, etc.). The core objective should be to monetise sovereign debts, allow governments to engage in large-scale expansionary fiscal policy that is commensurate with the debt monetisation scheme, and set price controls for practically all consumer goods.

The goal is to channel resources directly to the real economy at a time when economic activity has effectively stalled (the other option would be “helicopter money”). Households should witness a tangible difference in their purchasing power which, in turn, will send aggregate demand on an upward trajectory.

It is of paramount importance to tackle the coronacrisis at its root, otherwise the recession will transmogrify into an economic meltdown of colossal proportions.

A blueprint for such drastic measures has already been offered by Mario Draghi’s policy initiative following his famous “whatever it takes [to save the euro]”: the Outright Monetary Transactions. OMT was a debt monetisation plan linked to a programme of the European Stability Mechanism. In principle, Member States can use Enhanced Cooperation to employ EU institutions, such as the ECB, in the pursuit of policy initiatives that are outside the remit of the European Treaties though aligned with them. In effect, it is possible to circumvent any legal constraint on debt monetisation in order to save both the average European citizen and the EU/Euro architecture. This is with the proviso that policy-makers rise to the challenge of this unique historical occasion.

There is no such thing as a legal obstacle to survival. The challenge we Europeans have always been confronted with is to find ways of escaping from the shackles of pernicious ideology. It is ideological narrow-mindedness that guided policy-makers to blithely exacerbate the eurocrisis by imposing grinding austerity amid a general collapse in aggregate demand. It is ideology that keeps the ECB captive in this role-playing game of trying to help the real economy while actually sponsoring the speculative bonanza of unscrupulous investors.

Unlike the timing of the eurocrisis, the coronacrisis comes at a point where our economies and the welfare state have already been devastated by years of misguided austerity. Those in power must be immediately challenged to reconsider their mindset, emancipate themselves from the path-dependency of their past policy initiatives, and act in the longer-term interest of Europe at-large. Else I fear we will suffer much—MUCH—more than we already have.