Quantitative easing has quickly become one of those strange phenomena about which everyone professes expertise but, in reality, nobody understands. Commentators who should know better pronounce on what QE is likely to bring without really having the faintest idea of what it is or how it supposed to work in theory, let alone practice. Pronouncements about the potential for more bank lending and improved consumer spending are produced from thin air.
The only thing the European Central Bank is permitted to target is inflation. Nothing else comes within its remit (unless we start talking about banking stability and regulation). QE is designed to bring inflation back to target, close to but less than 2 per cent. The ECB is not in business to promote growth, target the exchange rate or lower unemployment. Its job, expressed with unambiguous clarity via its legal mandate, is to deliver a particular outcome for inflation, using the standard tools of monetary policy. The reason why the debate has become legalistic is that nobody in Germany thinks QE should be in the toolkit of any central bank.
Counterintuitive economics
Monetary theory – and practice – is not simple. It is often counterintuitive. Most of the instant experts need to reflect on this. Even something as seemingly straightforward as a central bank’s set of accounts will quickly challenge any commentator’s analytical skills. All of that guff about risk-sharing (of the potential losses from QE), for example, ignores the simple fact there is nothing at all that prevents a central bank from running with negative net worth: insolvency is a concept that evaporates in the murky world of central bank balance sheets. Ordinary banks can go bust, central banks in most modern economies cannot. Counterintuitive indeed.
The German critics of QE suspect mandate slippage: economic growth is something now being targeted. Mario Draghi almost certainly hopes higher inflation is accompanied by higher growth but has to be indifferent as to how it is achieved. In the strange world of monetary economics, higher inflation can come about simply because people expect it. That may, or may not, be accompanied by lower unemployment.
Jens Weidmann, the most prominent German critic of QE, thinks the European economy doesn't need it. In a narrow sense, he has a point. Amid all of the furore around QE, the release of some key economic data was ignored. Markit Purchasing Manager indices rarely get the pulse racing but they are, usually, closely watched and market-moving. When they were released at the end of last week, they confirmed something that a recent run of data has been hinting at: the euro area economy has touched bottom and may even be staging a very mild recovery. Few people noticed. Indeed, putting "Europe" and "economic growth", in the same sentence fits few popular narratives.
The debate over short-term economic stimulus and long-term structural reform is often cast in terms of one versus the other. It is a dishonest argument: Europe needs both. Neither can proceed without the other. It is bone-headed for the German establishment to deny the cyclical problems facing Europe and to pretend "structural reforms" will cure all ills. It is equally mendacious for others to argue short-term stimulus is all that is needed.
Relief v reform
The argument over debt relief is almost as shallow. Critics who point to the forgiveness of German debt after the second World War always fail to talk about what happened next: serious structural German reforms combined with that debt relief to produce the world-beating economy we see today.
If Europe’s periphery were to be granted similar forgiveness, do we seriously imagine a similar outcome? What would we do with the cash granted by debt relief, the interest payments we wouldn’t have to make? Investment in the infrastructure of our economy or higher public sector pay?
European QE is often unfavourably contrasted with similar policies in the US and UK. Most commentators have suggested that Europe’s version is too little too late. But one difference between the ECB and those other central banks is that Draghi may be like Napoleon’s favourite general: lucky. He may have given a push, via a massive euro devaluation, to an economy that has already bounced off the bottom, helped in no small part by a 60 per cent fall in the oil price. QE works in mysterious ways.
