The European debate about quantitative easing -- the equivalent of applying a central bank defibrillator to a failing economy -- has reminded me of Zeno’s paradox of motion: Achilles could never catch a tortoise because whenever he bridged the distance, the tortoise advanced.
Same here: Whenever conditions seem to be in place for QE, new ones pop up.
But all that changed last Thursday. The European Central Bank voted to elevate the €1 trillion increase in the size of its balance sheet from something it expected to happen to something it intends to accomplish.
This is more than a rhetorical change. Without QE, the target cannot be reached. By committing to this number, the ECB in effect has agreed to QE.
Those who have opposed the program know that once the ECB has a balance sheet target, QE will follow by default. The ECB’s existing programs are not big enough to reach that goal.
In light of this new situation, the question is no longer whether QE will happen, but how it will work.
I would expect the size of any program to be about €500 billion. With that, the balance sheet target could be in reach. So what would €500 billion buy?
The total amount of the eurozone’s government debt is about €9 trillion, so such a program would just be 5.5 percent of the total. Compare this to Britain, where the Bank of England’s stock of government debt was about 25 percent of the total issued as of 2013.
If the ECB wanted to do as much as the Bank of England did from 2009 onwards, in relative terms, it would have to commit to asset purchases of more than €2 trillion. In fact, it has to do quite a bit more because it has started much later, and because the situation in the euro zone is more serious.
If the ECB wanted to do as much as the Bank of England did from 2009 onwards, in relative terms, it would have to commit to asset purchases of more than €2 trillion.
Those on the ECB’s governing council who oppose QE fear that it would trigger a larger program later on. This is why I expect Berlin to mount a legal challenge in the European Court of Justice. A €2 trillion programme, or something approaching that, would have a similar economic effect to a euro-zone bond — that is, a jointly issued debt security — which is something Germany has been resisting.
In that scenario the ECB would absorb a big chunk of the outstanding debt of highly indebted euro-zone countries, and keep it on its books forever.
The alternative to a large program is an inadequate one — for example, one that stops at €500 billion. It would meet less opposition in Berlin. Unfortunately, it would also be economically irrelevant.
To see this, one should consider the channels through which QE works.
The most direct impact would be on the interest rates of the securities purchased. If the central bank buys five-year government bonds, the price of those bonds will rise and the yield will fall. Since those bonds serve as a benchmark for bank loans, the interest rates on banknotes may fall as well, in theory, though probably not in the euro zone.
Then there is the “portfolio rebalancing channel.”
When banks sell bonds to the ECB, they will need to buy something else instead. They might lend it out. They might buy other risky securities. This may well be the most important effect but it will probably not be as effective as it was in the United States and Britain, when asset prices were lower.
What about the exchange rate? This is the most overrated channel. The euro’s trade-weighted exchange rate has fallen by only 4 percent in the past year. It could come down a little further, but this is not going to do the heavy lifting. The euro zone is simply too big for that.
The only truly significant conduit of a QE program would be a debt relief channel. If the ECB were to buy, and retire, a quarter of Italian debt, life in Italy would become a lot easier. That, however, is not going to happen — either because the program is too small or, if not, Berlin would challenge it legally.
If you want to push the money through these channels into the economy, you will need a lot of money and a lot of pushing. Ideally, you would not start from here but from where the U.S. Federal Reserve or the Bank of England started in 2008 and 2009 respectively.
My fear is that a European QE program will happen but still stay trapped in Zeno’s paradox.
The writer is the director of Eurointelligence, a specialist, Internet-based service for information on the euro zone. This opinion article originally appeared in The Financial Times. To reach the author: [email protected]