Will QE Help?

As an antidote to deflation, the European Central Bank (ECB) said that its own QE program will be rolled out in March. It’s been a long-awaited shot in the arm for the eurozone. The package includes injecting 1.1 trillion euros ($1.3 trillion) through the purchases of government bonds and private sector assets, worth 60 billion euros ($69 billion) a month, until the inflation rate shows signs of improvement, according to ECB president Mario Draghi.

Guillén says the goal is to essentially print money so inflation will accelerate. Investors and consumers should see prices go up in the future, so the idea is to jumpstart economic activity. But quantitative easing in the eurozone has arrived late in the game. The U.S. is winding down the QE program it embarked on six years ago when low inflation rates first started to raise alarm.

In Europe, decision makers — not just the ECB but Germany, Finland, Austria and the Netherlands — should have considered sooner the impact of weathering three recessions in eight years in the region, says Guillén. With each recession, unemployment grew. “Young people and older workers can’t easily find other jobs and it creates a very difficult social situation. People don’t have enough money to spend.”

“It’s not going to shoot us back to 2% inflation, but a looser policy is a prerequisite for a sustained move back to a moderate rate of inflation.” –Olivier Chatain

No one knows whether or how much deflation will be staved off in the eurozone with the QE plan, Chatain warns. “My impression is inflation will move a little bit, but not massively. It’s good, necessary, but coming in late. It’s not going to shoot us back to 2% inflation, but a looser policy is a prerequisite for a sustained move back to a moderate rate of inflation.”

Also important to note is that QE will not work the same in the 19-member country eurozone as it has in the U.S. “Overall, Europe’s range of possibilities and channels that can work through the economy are smaller than in the U.S. The effect could be weaker, but it’s hard to say,” notes Eckhard Wurzel, an economist with the Organisation for Economic and Co-operation and Development (OECD).

Guillén says the ECB will buy government bonds, but it won’t be on the books of the centralized monetary body. The ECB is a federation of national central banks of its member countries — if the Greek government defaults, for example, it won’t be the ECB, much less Germany, that will suffer; it will only be Greece. “The ECB is telling everybody it will be buying all these bonds, but the burden will be put on the balance sheets of the individual countries’ banks,” Guillén notes. “The market is not pooling risks in Europe. It’s letting each country handle its own risks. It’s like saying if unemployment is high in Ohio, then only Ohio will be responsible instead of the whole country. It’s a mixed message and not very reassuring.”

ButDraghi’s plan might have been the only way to pass muster with powerhouse Germany. Steffen Kampeter, German’s deputy finance minister, recently told CNBC that Europe was not facing a deflation spiral. He pointed out that in December, German consumer demand was at its peak in eight years and that Germany could exceed the 1% growth rate predicted for 2015. Nevertheless, Germany’s flash inflation rate slowed to its lowest level in five years in December. “You have people who still say there is no deflation risk, and those people took a long time to negotiate with,” adds Chatain.

Meanwhile, Switzerland — already in deflation, but not in the eurozone — recently called quits on holding its Swiss franc to a value of 1.20 to the euro just before the QE program was announced. “This is going to cause extreme pain for parts of the Swiss economy,” said David Owen, an economist with the investment firm Jefferies, in a Telegraph article.

As the Swiss economy settles down, the ECB wants to weaken the euro so Europe will be more competitive with other countries. Currently, the euro has hit an 11-year low against the U.S. dollar. “Though he wouldn’t say it explicitly, Draghi would love for the euro to be at parity with the dollar,” says Schwarz.

“The market is not pooling risks in Europe. It’s letting each country handle its own risks. It’s like saying if unemployment is high in Ohio, then only Ohio will be responsible instead of the whole country.” –Mauro Guillen

To illustrate the impact of the state of the euro, Chatain points to the example of airplane manufacturers — Airbus in France and Boeing in the U.S. “American products might be more expensive in Europe, yielding few American imports into Europe. If you’re producing goods in the U.S. and you want to sell in Europe, the currency movements make that harder,” he notes. “Conversely, European firms can offer discounts in the U.S. while keeping profitability constant.”