DRAGHI OPENS EUROPE´S MONETARY SPIGOT AT LAST / THE FINANCIAL TIMES VIEW

January 22, 2015 3:17 pm

 

Draghi opens Europe’s monetary spigot at last

Eliminating eurozone deflation will require sustained treatment

 

©Bloomberg

 

It has taken far too long for the European Central Bank to embark on quantitative easing but its belated action is no less welcome. On Thursday, Mario Draghi announced that the ECB will purchase €60bn per month of eurozone bonds up to the end of 2016 to fight off incipient signs of deflation.

 

Mr Draghi faced a daunting challenge in meeting expectations of a monetary boost that have grown all year. Thursday’s initial market response is that he did not disappoint. At the time of writing, the euro has weakened significantly against other major currencies.

There is no doubt that Mr Draghi needed to act. Growth and underlying inflation have been relentlessly weak, providing clear evidence that demand in the eurozone is faltering.

Critics have deployed many arguments to delay eurozone QE. None is convincing and taken together they are incoherent. Pessimists argue that monetary stimulus cannot work in a world of low interest rates and cautious banks. Inflation hawks fear that money printing leads to runaway inflation. Others complain that buying the bonds of struggling countries “rigs the market” and eases the pressure towards structural reform.

Clearly these critics cannot all be right, and it is likely that none is. Hyperinflation is one of the more fanciful bugbears of this recovery. In any case, most developed economies would clearly benefit from higher inflation, and central banks have any number of ways of reining it in, should that become necessary.

The claim that monetary policy is inert when interest rates are low is belied by the recoveries in the US and UK. Switzerland provides even starker proof. In 2011, the imposition of a cap on the value of the Swiss franc loosened money and helped growth. Its removal has sharply tightened Switzerland’s monetary stance and could now throw it deeper into deflation. The level of interest rates plays no clear role in this switchback ride.

 

That is just as well, because bond yields across Europe have been plumbing record lows: less than 0.75 per cent in Germany and France, and 1 percentage point higher for Italy and Spain. The most valid criticism of QE is that with government borrowing being nearly costless, fiscal policy should take more of the strain.

 

Low bond yields are an expression of doubt in the markets that the ECB will be effective in restoring growth and inflation. Such reservations reflect the constraints under which Mr Draghi has to labour.

His most potent weapon ought to be an ability to commit to whatever is needed to hit his target.

Markets are ill inclined to fight a steadfast central banker. On the flipside, consumers and businesses who doubt that inflation will be high have less reason to spend or invest. Mr Draghi has been hampered from being so resolute by the recalcitrance of others at the ECB. After Thursday the indications are that he is up for the fight, particularly in his hint that QE will be open-ended until there have been a “sustained adjustment” in inflation back to its 2 per cent target.

Less welcome is a confirmation that national central banks will be forced to bear most of the default risk from bond purchases. While this should not stop QE gaining traction, it may cast doubt on the endurance of the policy.

To escape years of enervating weakness the eurozone needs not just a shot in the arm but a long course of treatment. Neither the markets nor his ECB critics think that Mr Draghi has the tools to finish this job. For him to prove them wrong, eurozone governments should show equal resolve.