Quantitative Easing Making EU Investments Stronger

Quantitative Easing, a rather unconventional monetary policy, has been used extensively in recent times. Many major central banks, such as the Federal Reserve, Bank of Japan, and the European Central Bank, have resorted to this policy to kick-start their economic growth.

Quantitative Easing works by injecting liquidity and pulling down interest rates simultaneously, which contributes to higher-borrowing and spending activity amongst consumers, promoting economic growth.

Impact of Quantitative Easing on EU Investing Strategies

Image Courtesy: St. George Utah

When conventional monetary policy fails, unconventional tactics, such as QE come into play. When short-term nominal interest rates cannot be reduced further to stimulate economic activity, The Fed buys debt and MBS from commercial banks with the help of QE, in exchange for money that is created electronically. This increases the Fed’s balance sheet by the number of assets purchased.

Post the 2008 recession, the US economy was not responding well enough to the conventional monetary policy and the fiscal stimulus package sanctioned in 2009. The Fed, at that time, introduced quantitative easing, assuming it would accelerate the value of assets, increasing household wealth and ultimately driving up consumer spending.

Sure enough, the strategy worked well and the US saw an upsurge in share prices by 30% in 2013, and in house prices by 13% in the same twelve months.

The rise in wealth induced consumers to increase their spending resulting in starting off the usual expansionary multiplier process. As a result, GDP went up by 2.5% in 2013 and the unemployment rate came down to 6.7% from 8%. Furthermore, the expansion continued, bringing down the general unemployment rate to 5%, dropping further to 2.5% among college graduates.

Now that the US Federal Reserve’s policy of QE has been successful, the bigger question remains:

“Will the ECB ever be able to translate quantitative easing into stronger economic growth and higher inflation, just like the US?”

Impact of Quantitative Easing on EU Investing Strategies

Image Courtesy: Guardian

The ECB has been following a similar strategy of large-scale asset purchases and extremely low (indeed negative) short-term interest rates. But, although the policy is the same as the Fed’s, its purpose is very different.

Europe doesn’t have the general share ownership that exists in the United States. To simply stimulate consumer spending through quantitative easing by raising household wealth is not possible. Instead, a major purpose of the ECB’s low-interest-rate policy has been to stimulate net exports by depressing the value of the Euro. The ECB succeeded in this, with the euro’s value falling by some 25% – from $1.40 in the summer of 2014 to $1.06 by the fall of 2015.

This strategy will most likely not work in the Eurozone, because the unemployment rate is still nearly 12%, higher than before the recession began. Through increases in import prices because of the declining value of the Euro, the ECB’s quantitative easing policy can probably achieve higher inflation. This very limited process still leaves core inflation in the Eurozone below 1%.

Eurozone financial markets reacted as expected. Long-term interest rates fell, equity prices rose, and the Euro declined relative to the dollar. But past experience and the reasons spelled out here suggest that these policies will do very little to increase real activity and price inflation in the Eurozone. To make real progress toward reviving their economies, the individual countries need to depend less on quantitative easing by the ECB, and focus squarely on structural reforms and fiscal stimulus.

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