The eurozone could do with a dose of QE, but don't hold your breath

I am not an unqualified enthusiast for QE and never have been but, since both the US and the UK, which have operated QE, have staged a reasonable recovery and the eurozone has not, the burden of proof surely rests with the naysayers.

When QE was first launched, quite a few economists thought that by looking at past relationships it was possible to calculate how much would be needed to boost aggregate demand by a given amount. This was always complete poppycock. When you have just come through the greatest financial crisis since the 1930s you cannot expect behaviour to be the same as it has been on average over the past few relatively quiescent decades.

On the other hand, I never accepted the stern warnings of those who said that QE represented the road to Harare. The whole point of QE was to persuade people and companies to spend money and, thereby, to stimulate economic recovery. It would only be if and when this got out of hand that the inflationary danger would loom and, frankly, in the conditions of the past few years, that would have been a nice problem to have.

There is no technical difficulty about re-absorbing the money created by QE, you sell bonds to the markets and/or impose reserve requirements on the banks to soak up excessive liquidity. Yes, central banks could misjudge the time and the amount of action that they needed to take (in both directions, by the way) and the policy risks creating bubbles and distortions in financial markets and in the real economy, which you have to keep an eye on but, if QE got the economy out of the worst recession since the 1930s, then these were risks worth taking. That is what I thought then and still do.

The really attractive thing about QE is that, even though you do not know how much of it will be needed, theoretically anyway, there is no limit to how much of its own money a central bank can create. Therefore, if some amount of QE proves insufficient to do the job, you can just do more and so on ad infinitum.

Once firms and individuals in the system understand your ability and appreciate your will to do as much as necessary, that will strengthen their belief in the policy’s likely success and, thereby, make it all the more likely that a small dose of the medicine will do the trick.

If, by contrast, they think that the policy will be only hesitantly implemented and might soon be stopped, or even reversed, then the effect may be minimal. That was Japan’s experience when it dabbled with QE in the early 2000s.

Unfortunately, if the ECB ever gets round to adopting a policy of QE, this is where the central bank’s own characteristics are likely to stymie the policy.

It is well known that the Bundesbank is congenitally opposed to QE. Recent signs of flexibility by its president, Jens Weidmann, may be merely tactical. At the very least, there will always be a suspicion that if the ECB starts doing QE then the Bundesbank could at any moment call a halt. You cannot over-emphasise the intensity of this institution’s distaste for inflation. Its opposition to QE is theological. Anyone exposed to a detailed exegesis of the Bundesbank’s view of the evils of monetary financing is liable soon to lose the will to live.

The eurozone authorities are in the current, near-impossible, situation largely because of the euro. Accordingly, the euro should break up. If this cannot be allowed to happen for political reasons then the next, least bad, option is to have a higher rate of inflation for the eurozone as a whole, with the peripheral countries having a lower but still positive rate. That would allow them to regain competitiveness vis-a-vis the core countries without having to undergo deflation.

To achieve this end, a deliberate policy of outright QE is needed. But as regards the whole-hearted embrace of this policy I wouldn’t hold your breath. I sense yet another euro fudge coming along.

Roger Bootle is managing director of Capital Economics. Contact him on roger.bootle@capitaleconomics.com

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