Quantitative Easing by ECB

Date: January 24, 2015

ECB Inflation Deflation Quantitative Easing Europe

Bond-Buying Programs of ECB

The European Central Bank (ECB) on Jan 22nd announced to introduce a big programme of quantitative easing. It announced higher-than-expected monthly bond-buying programme of 50 billion euros (£38bn) that will go on till September 2016. By September next year, more than 1 trillion euros will have been created under quantitative easing, the ECB's last remaining major policy option for reviving economic growth and warding off deflation. The European markets reacted positively after the announcement.

The ECB and the central banks of euro zone countries will buy up bonds in proportion to its "capital key", meaning more debt will be scooped up from the biggest economies such as Germany than from small member states such as Ireland.

Reasons for ECB's move- 

The European economy is in a very weak position. There are problems of huge unemployment, low Growth, and dangerously low inflation.The low inflation trap results in companies decision to put off investment and also consumers stared delay purchases . If it worsens, Europe could face the widespread decline in prices known as deflation, which hurts companies’ profits and leads them to lay off workers.

In such an environment, central banks usually resort to cutting interest rates. But the European Central Bank has already lowered its benchmark rate to 0.05 percent, effectively zero. It has even imposed a negative interest rate on bank deposits held at the central bank.The E.C.B. has also been lending more money to commercial banks at rock bottom rates. But demand from banks has been tepid.

So quantitative easing is the next logical step — and perhaps the central bank’s only option.

Important Terms

Government bonds-

Governments borrow money by selling bonds to investors. A bond is an IOU. In return for the investor's cash, the government promises to pay a fixed rate of interest over a specific period - say 4% every year for 10 years. At the end of the period, the investor is repaid the cash they originally paid, cancelling that particular bit of government debt.

Quantitative Easing-

Quantitative Easing is an unconventional monetary policy in which a central bank purchases government securities or bonds from the market in order to lower interest rates and increase the money supply. It  increases the money supply by flooding financial institutions with capital in an effort to promote increased lending and liquidity.

It was first used by the Bank of Japan in the early part of the 2000s; the Federal Reserve and the Bank of England introduced it in the wake of the financial crisis of 2008.

QE Prepare

Risks for Europe

The biggest risk may be political. Government bond purchases prompt fear and loathing in some northern countries, notably Germany. People worry that they could wind up stuck with the bill if a country defaults. Quantitative easing could alienate a significant number of Germans and reduce support for the eurozone coalition, which has already suffered because of the region’s poor performance during the last five years.

There has been speculation that the European Central Bank may try to address German concerns by delegating bond purchases to the national central banks, which in theory would absorb any losses. But the speculation highlights another risk — that the E.C.B. will make too many compromises and dilute the impact of quantitative easing. Critics say delegating to the national central banks would undermine the idea of a single currency with a strong central bank. Others say it might be necessary to mute criticism from Germany.

 

Suggested question for mains-

EUROPEAN CENTRAL BANKS BOND PURCHASING PROGRAMME KNOWN AS QUANTITATIVE EASING(QE) WILL DO ENOUGH TO STOKE EUROPE’S FRAGILE ECONOMY. EXAMINE THE REASONS FOR ECB STIMULUS AND ITS IMPACT ON EMERGING MARKETS ESPECIALLY INDIA?(200 WORDS)