QE in the Eurozone and the ECB

MASTER IN EUROPEAN S TUDIES The Quantitative Easing and the European Central Bank Submitted by: Manfredi Morello Student number: CSU010014 Submission date: 28th February 2017 Course title: European Macroeconomics Course instructor: Piero Esposito Table of Contents Abstract ........................................................................................................................... 3 Introduction ..................................................................................................................... 4 Part I: Genesis and progress of Quantitative Easing ....................................................... 5 1.1 What is “Quantitative Easing”? ................................................................................ 5 1.2 Inflation targeting and aggregate growth .................................................................. 6 1.3 Quantitative easing announcement in the Eurozone ................................................. 6 1.4 The Public Asset Purchase Programme .................................................................... 7 Part II: The effects of Quantitative Easing over the real economy ................................. 8 2.1 The “channels” of Quantitative Easing ..................................................................... 8 2.2 A critique of the “channels” ...................................................................................... 9 Conclusions ................................................................................................................... 10 Bibliography .................................................................................................................. 11 Abstract This paper is an attempt to conduct an analysis of the origins and the primary outcomes of ‘Quantitative Easing’ that European Central Bank has been implementing since March 2015. The aim of the paper is to show the effectiveness of Quantitative Easing and the responsiveness of the Eurozone to obtain the expected results. Although the general idea is that QE effectively sustained economic recovery from the 2012 Global Financial Crisis, some critiques have been enhanced by academics: all these important evaluations would be taken into account in the completion of this work. The analysis will be conducted through the usage of updated statistics regarding the main macroeconomic indicators which might assess either the results either the prospects or the consequences which Eurozone would face after QE’s ending in the short-run. Keywords: Quantitative Easing; European Central Bank; Unconventional Monetary Policy; PublicAsset Purchase Programme Introduction Since the Global Financial Crisis of 2012, the traditional (or conventional) monetary policies had no effects neither on economic recovery nor on inflation. Growth levels around the world have been diminishing, inflation rates have dramatically diminished. In particular, the Eurozone, which is one of the most important economies of the globe, has experienced a recession from which it has been questionable to find a “way out”. Given the poor effect that open market operations displayed, the ECB opted for other kinds of monetary policy to correct inflation rate: one of those unconventional monetary policies is quantitative easing. Quantitative Easing was not entirely new: firstly in 2000, the Bank of Japan conducted a similar policy to recover its ‘hysterical’ negative inflation levels, secondly the Federal Reserve ran QE in 2009, and also the Bank of England implemented QE in 2009. The common point is that in all the three previous cases QE showed positive effects on the respective inflation rates. For that reason, since 2015 the European Central Bank stated that it would use new instruments of monetary policy to achieve the aimed level of inflation: in January 2015 Mario Draghi, Governor of the ECB, announced the activation of the ECB QE: the ECB would have conducted a monthly purchase of bonds and assets from either the public or the private sector. The scope was to maintain price stability and to give a push to inflation by reaching a level close or below 2%. QE has incorporated three different programmes of bonds acquisitions from the private or public sector or both of them: since 2015 the ECB has conducted the Covered Bonds Purchase Programme, the Asset-backed securities Purchase Programme and the Public Sector Purchase Programme. Those programmes differ according to the type of assets (riskier securities, securities which include mortgages or debt bonds) that the ECB bought or according to the economic sector to which it was directed (private or public). QE affected the real economy as well via Aggregate Demand “channels”. In the second part of this work, I will identify the different “channels” of QE in order to assess whether one channel has prevailed over the others or not. To fulfil this objective, this paper will discuss the views of Giavazzi and Tabellini ( vox.eu , 2015) . Part I: Genesis and progress of Quantitative Easing 1.1 What is “Quantitative Easing”? Quantitative easing is a kind on unconventional monetary policy with which the monetary authority (often the central bank) injects liquidity in the real economy with a programmed and large acquisition of debt bonds or securities in the interbank market. This massive acquisition would diminish the price of bonds which is inversely related to their interest rate (or yield) with a sequence of cause-effects results on the real economy which would lead to an increase of the Aggregate Demand and the Real GDP. Quantitative easing (or QE) is the massive purchase of public and private assets took in place by European Central Bank (in short the ECB) to stimulate the incoming economic growth in the Eurozone. Since the crisis of 2009, the Eurozone had experimented a long period of recession which was not adjusted by the conventional monetary policies ( As it is widely held known, the ECB can expand or tighten the Money Supply in order to increase or reduce the interest rate. This is the so called “conventional monetary policy” which monetary policy’ authorities had traditionally adopted. However, this is rather a simplification. In fact, the economists Olivier Blanchard1, Alessia Amighini and Francesco Giavazzi give a better explanation of what a monetary policy is: “In modern economies, the way that central banks change the supply of money is by buying or selling bonds in the bond market. If a central bank wants to increase the amount of money in the economy, it buys bonds and pays for them by creating money. If it wants to decrease the amount of money in the economy, it sells bonds and removes from circulation the money it receives in exchange for the bonds. These actions are called ‘open market operations’ because they take place in the ‘open market for bonds’.” The explanation the authors give in that case is that the Central Bank2, which independently conducts monetary policy measures, can only buy or sell bonds in the secondary market and this in theory creates a set of indirect effects which finally make the interest rate increase or fall, depending on whether it is a purchase of bonds (expansionary monetary policy) or a selling of bonds (contractionary monetary policy). However, an expansionary monetary policy, instead of triggering a growth stimulus for the Eurozone had to content with a persistent slow growth or a moderate recession: traditional or conventional monetary tools seemed to not have showed the expected results anymore. 1 O. Blanchard, A. Amighini, F. Giavazzi; “Macroeconomics. A European Perspective” (Edinburgh, Pearson, 2012), 65 In 2000, the Bank of Japan decided to adopt a different monetary policy: instead of intervening in the goods market by affecting the Monetary Supply, the Japanese Central Bank tried to boost growth by purchasing massively bonds and consequently reducing indirectly the interest rate in the interbank market. This was due to the fact that interest rates did not respond anymore to the expansion of money supply in the financial market. As stated above, the monetary authorities of other countries (Bank of England, FED, ECB) decided to adopt thi new monetary policy tool. 1.2 Inflation targeting and aggregate growth In 2012 the ECB had tried to recover from the Global Financial Crisis by conducting an expansionary monetary policy without any short-run effective outcome: the market had not responded to the inflationary policies that the ECB had been conducting. The European Central Bank is in charge of maintaining “price stability” in the Eurozone. According to the TFEU, inflation rate in the Eurozone must be close or beyond 2%. Let’s now focus on inflation rate annual variation contemporarily to the Global Financial Crisis: the website inflation.eu3 estimates that in 2012 inflation rate amounted to 2.2% and inflation targeting was nearly reached. However, since 2012 (i.e. when the Global Financial Crisis started) the inflation rate has dramatically diminished: in 2013 it amounted to 0.85%, in 2014 it was worth -0.17% and in 2015 it amounted to 0.23%. As data show, inflation targeting was far from being reached in 2015. Despite the fact that since 2012 the ECB had conducted an expansionary monetary policy, (i.e. diminishing the interest rate) real GDP growth rate has increased little: in 2013 it amounted to 0.2%, in 2014 it reached 1.6% and in 2015 it amounted to 2.2%: Europe was still far from recovering from the Global Financial Crisis. Economists have been widely discussing the reasons of theese negative effects: some insisted on the lack of fiscal accommodation from member states’ governments, others accused member states’ regional structural differences or lack of structural reforms as the main obstacles to economic recovery. I will not discuss this complex matter in this paper: the point is that conventional means of monetary policy did not work, or somehow did not work enough. 1.3 Quantitative easing announcement in the Eurozone On January 22nd 2015 the ECB’s President Mario Draghi announced Quantitative Easing with a press Conference: The European Central Bank would start a monthly purchase of bonds both from the public and from the private sector whose value was set as 60 billion of Euros. In fact, in the press conference Mario Draghi4 said: 3 Data taken from the website inflation.eu (available at: http://www.inflation.eu/inflation-rates/europe/historicinflation/hicp-inflation-europe.aspx ) 4 European Central Bank, “The ECB announces expanded asset purchase programme.”, Mario Draghi press release, 22nd January 2015 available at: (https://www.ecb.europa.eu/press/pr/date/2015/html/pr150122_1.en.html) last visit: January 23rd 2017 “The ECB will buy bonds issued by euro area central governments, agencies and European institutions in the secondary market against central bank money, which the institutions that sold the securities can use to buy other assets and extend credit to the real economy. In both cases, this contributes to an easing of financial conditions”. In the next section I will explain the configuration of the Quantitative Easing in the Eurozone: The Public Asset Purchase Programme. 1.4 The Public Asset Purchase Programme With the abovementioned press conference, the European Central Bank announced the implementation of the Public Sector Purchase Programme (PSPP) in two months’ time. This programme would consist of a purchase of bonds either from the public or the private sector. The PSPP would be complementary to the previous purchase programmes, The Covered Bonds Purchase Programme (CBPP) and the Asset-Backed Securities Programme (ABSP). This setup reflects the ECB’ wish of continuity with its previous monetary policy modalities towards the Eurozone. The Third Covered Bonds Purchase Programme (CBPP) of October 2014 was a purchase only of securities which were highly ‘liquid’ and less risky than the following Asset Backed Securities Programme of November 2014, whose securities were characterized by collaterals composed either of mortgage loans either of other types of financial assets. Moreover, according to G. Claeys, A. Leandro and A. Molina5: “Under the PSPP, the Euro system will buy sovereign bonds from euro-area governments and securities from European institutions and national agencies.” As the two economists specify, the PSPP extended the range of purchasable assets: actually, with the PSPP the acquisitions would include not only public bonds but also assets from the member states’ national agencies. But, although the means to realize the objective are even wider since March 2015, the ECB’ target remained the same: to boost the inflation rate close but below 2%. Having explained the composition of PSPP, we turn now to the analysis of its effects on the real economy. G. Claeys, A. Leandro, A. Molina, “European Central Bank’ Quantitative Easing: the detailed manual”. Bruegel Policy contribution, issue 2015/02, March 2015 5 Part II: The effects of Quantitative Easing over the real economy 2.1 The “channels” of Quantitative Easing This figure is taken from a recent Bundesbank’s report6, where experts analysed the QE of the ECB and its “transmission process” on the real economy. In fact, there are a series of cause-effects which would make the ECB’s QE generate inflationary effects in the short run. The first real effect of QE comes from the interbank market: in fact, as the upward part of the figure shows, a massive purchase of bonds from the public sector would, on one hand, increase the stock of government bonds in the ECB’s balance sheet; on the other hand, the purchase of bonds would affect their yields and finally bring down the interest rates. This would enhance a “triple” effect within the components of the Aggregate Demand. In other words, a decline in interest rates causes an increase Deutsche Bundesbank, The 2016, p. 35 6 acroeco o ic i pact of Qua titative Easi g i the Euro Area , monthly report, 29 June in Investment, a depreciation of the currency (i.e. of the Euro) and a rise of asset prices: these are the first effects of QE on the real economy and can be simply defined as the “channels” of QE. But after the first chain of causes-effects, a second round of indirect effects influence the goods market: in fact, according to the figure reported above, the rise of asset prices together with the fall in interest rates and the depreciation of the currency cause a rise of the demand and of the supply of labour, which, by producing a rise of wages and of imports’ prices, results in an inflationary pressure on the real economy. 2.2 A critique of the “channels” What is interesting to take from the academic discussion is the identification of the ‘channel’ with which QE affected the inflation rate of the Eurozone. An important evaluation was made by Giavazzi and Tabellini (2015). In an article published on the website vox.eu they7 wrote: “QE affects the aggregate demand through several channels… […] The exchange rate channel is more important, but here too there are some doubts: The Eurozone is a small open economy (external exports are only 20% of GDP) and the euro has already weakened considerably.”. These two economists point out that, even the depreciation effect of the Euro, though the most significant, may have failed in stimulating the real economy of the Eurozone as long as its effects on the Eurozone economy could be limited. Giavazzi and Tabellini have underlined the importance of fiscal policy coordination or QE effectiveness: “The key is that QE needs to be coordinated with fiscal policy […] The expansion of the Aggregate Demand can only occur if the government exploits the additional fiscal space created by QE to run a larger deficit through tax cuts or spending increases.”. Hence, according to Giavazzi and Tabellini the most operative “channel” of QE is the effect through the exchange rate, but QE cannot succeed if fiscal policies are not coordinated successfully. F. Giavazzi, G. Tabellini, Effective Eurozo e QE: size atters ore tha risk-shari g , vox.eu, January 17th 2015, available at: http://voxeu.org/article/effective-eurozone-qe-size-matters-more-risk-sharing, last visit on February 1st 2017 7 Conclusions QE in the Eurozone has partially had the expected outcomes since its implementation. In fact, in the Eurozone QE has provoked a partial rise of the inflation rate of the Eurozone towards its objective of 2%. However, a final evaluation of QE success would wait for long-run inflation rate effects. What has been evident is that, in the short-run, inflation rate has risen to a level closer to 2% managing to leave those unsustainable levels that had contributed to paralyze the Eurozone economy. Moreover, it also looks like that Quantitative Easing contributed to stimulate the GDP growth of the Eurozone, even though to a limited extent. Then, QE affected the real economy via a direct effect on interbank market and on the financial market whereas the effect on the labour and goods’ markets was indirect. Throughout this paper it was possible to explain and observe all the intermediate steps with which, at the end, QE is proved to be an inflationary instrument of monetary policy and therefore an “unconventional” but effective mean at the disposal of the European Central Bank for the future challenges. Finally, the paper has contemplated which one of the “channels” considered above is the prevailing one: the result was that there is not a predominant component of the Aggregate Demand that was affected by Quantitative Easing more than others, what is instead apparent is that QE affected the Aggregate Demand via the exchange rate, the price of assets and the interest rates. Bibliography Blanchard O., Amighini A., Giavazzi F.; “Macroeconomics. A European Perspective”, Pearson, Edinburgh, 2012 Claeys G., Leandro A., Molina A., “European Central Bank’ Quantitative Easing: the detailled manual”. Bruegel Policy contribution, Issue 2015/02, March 2015 Deutsche Bundesbank, “The Macroeconomic impact of Quantitative Easing in the Euro Area”, Monthly report, 29 June 2016, available at: https://www.bundesbank.de/Redaktion/EN/Downloads/Publications/Monthly_Report_Articles/2016/ 2016_06_macroeconomic.pdf?__blob=publicationFile, last visit: 24 January 2017 European Central Bank, “The ECB announces expanded asset purchase programme.”, Mario Draghi press release, 22nd January 2015 available at: (https://www.ecb.europa.eu/press/pr/date/2015/html/pr150122_1.en.html) last visit: 23 January 2017 Giavazzi F., Tabellini G., “Effective Eurozone QE: size matters more than risk-sharing”, vox.eu, January 17th 2015, available at: http://voxeu.org/article/effective-eurozone-qe-size-matters-morerisk-sharing, last visit on 1 February 2017 Online sources: http://www.inflation.eu and in particular http://www.inflation.eu/inflation-rates/europe/historic-inflation/hicp-inflation-europe.aspx