photo: Chris Goldberg
Eight months have passed since the ECB started its own quantitative easing (QE) program, and almost everyone in Europe seems to agree with Mario Draghi that ‘QE has been a success’. But is such enthusiasm warranted? Let’s take a look at the data. The obvious starting place is the inflation rate. As is well known, the ECB’s mandate only foresees a single measurable objective – maintaining the inflation rate ‘below, but close to, 2 per cent’ – and it is thus logical to judge the central bank’s actions first and foremost according to this parameter (as narrow as it may be), especially since one of the stated aims of the ECB’s QE program is to bring the inflation rate back towards the 2 per cent target.
So how did the program fare in this respect? Not well: in September the inflation rate turned negative again (-0,1 per cent – coincidentally, the exact same level registered in March of this year, when the ECB launched its asset-buying program).
Focusing on whether the inflation rate is just above or below zero per cent is beyond the point, though: the fact of the matter is that the euro area’s average inflation rate – notwithstanding the huge inflation differentials between countries – has been below the ECB’s target of 2 per cent since late 2012, and below 1.5 per cent – which essentially amounts to deflation, according to a generally accepted guideline – since the beginning of 2013. That is, for almost three consecutive years.
If we look the GDP growth rate for the euro area, the conclusions are even more damning: as one can see in the following image, the growth rate actually starts to contract once again – putting an end to the slow climb commenced in 2014 – precisely a few months after the launch of the QE program, in March 2015.
Interestingly, many people credit QE for lowering government bond yields across the eurozone, but periphery bond yields have been steadily declining since 2012, with QE having almost no effect whatsoever on the general trend. The Italian-German bond spread provides a good case in point.
These numbers would be sufficient to dismiss the ECB’s QE program as a catastrophic failure and to call for a radical change of course. But let’s try to understand why European-style QE has failed so miserably. The main cause is without the doubt the continued, absurd and unjustifiable refusal on behalf of national and European authorities to take advantage on what is probably the main benefit of quantitative easing – the ability to run higher deficits while keeping borrowing costs down – to pursue a fiscal expansion, as the United States did in the aftermath of the financial crisis (and as advocated by growing number of mainstream economists and commentators).
What this means is that, when speaking of QE, it’s important to differentiate between QE as a purely monetary tool and QE as a monetary-fiscal tool: i.e., an expansionary monetary policy meant to facilitate an expansionary fiscal policy. The two are radically different. Unfortunately, European QE falls squarely in the first category: in other words, Draghi and the other members of European/national establishments continue to base their policy decisions on the assumption that monetary loosening is capable in itself – i.e., without the need for fiscal operations – of stimulating the economy, by easing credit conditions (thus boosting lending) and by depreciating the currency (thus boosting exports). The numbers tell a different story, though.
Let’s take bank lending. Even though bank lending in the eurozone is slowly increasing – and even accepting the dubious premise that economic recovery is dependent on increased lending –, it is still well below the level that would be needed. As one can see in the following figure, taken from a recent ECB report, the lion’s share of the growth in the money supply (M3) over the past year and a half is accounted for by an increase in credit to the public sector – explaining the continued rise in the euro area’s government debt –, not to the private sector.
According to a recent survey by Commerzbank, quantitative easing has had almost no effect on bank lending: on balance, roughly 85 per cent of the banks said that QE has not increased lending and practically no bank saw a ‘considerable’ effect of QE. As the report states, ‘liquidity is obviously no key factor that limits lending’.
This confirms what post-Keynesian theory has always advocated: banks do not ‘lend out’ reserves (or deposits, for that matter). The causality actually works in reverse: when a bank makes a new loan, it simply taps some numbers into a computer and creates brand new money ‘out of thin air’, which it then deposits into the borrower’s account. Only then, if it has insufficient reserves, does the bank turn to the central bank, which is obliged to provide reserves on demand. Pre-existing deposits aren’t even touched – or needed, for that matter. In short, the money supply, not unlike the rest of the economy, is endogenously demand-driven. This is why in the face of weak demand, where the economic and profitability prospects offered by the real economy are dim – not to mention in a deflationary-recessionary context such as the one that the eurozone finds itself it, in which balance sheets are being repaired, household and business demand for credit is weak, corporate insolvencies are on the rise and credit intermediation channels are impaired –, credit dries up, regardless of the amount of QE that a central bank engages in. This is known as a ‘credit trap’.
This is compounded by the fact that average euro area interest rates for companies and households are still relatively high – just above 2 per cent, in the face of very low or even negative inflation rates in a number of countries – despite ECB interest rates being at a historical low.
Both symptom and cause of the overall low level of lending – and the depressed state of the European economy in general – is the dizzying and rapidly-growing volume of non-performing loans (NPLs) across the continent. According to a recent study published on VoxEU.org, for the EU as a whole, NPLs stood at over 9 per cent of GDP at the end of 2014 – equivalent to a staggering 1.2 trillion euros, more than double the level in 2009. NPLs are particularly elevated in some southern countries, such as Italy, Greece, Portugal and Cyprus. And they are generally concentrated in the corporate sector, most notably among small and medium-sized enterprises (SMEs), which contribute almost two-thirds of Europe’s output and employment, and tend to be more reliant on bank financing than large firms.
This has worrying implications not only for the financial stability of the euro area but also for the prospects of economic recovery, given that ‘higher NPLs tend to reduce the credit-to-GDP ratio and GDP growth, while increasing unemployment’, the study states. This is a direct result of the austerity policies pursued in recent years, which have exacerbated the recession in a number of countries, further deteriorating the balance sheets of families and corporates and, in turn, those of banks. QE can do very little to stem this dramatic trend (and according to some studies it might actually have worsened it, by negatively impacting the profitability of banks through the lowering of interest rates).
This partly explains the silent die-off of European banks that has been underway since 2008. In its recent Report on financial structures, the ECB notes that in 2014 the total number of credit institutions decreased further to 5,614, down from 6,054 in 2013 and 6,774 in 2008. In other words, more than 1,000 credit institutions have disappeared or, more likely, have been gobbled up since the start of the crisis.
This means that we are in the presence of a financial system that is at once more concentrated and consolidated (and thus increasingly ‘too big to fail’) but also more fragile, and as a result less likely to support the real economy in any meaningful way. In such a context, hoping to ‘encourage’ banks to lend through quantitative easing is, at best, delusional.
And what about the second channel through which QE is supposed to stimulate the economy, the boosting of exports through a further depreciation of the euro? The eurozone is already running a current account surplus of 3.7 per cent of GDP, the largest in the world in nominal terms. A possible new round of monetary accommodation by the ECB could increase it even further. There are two reasons why this is unsustainable in the medium-long term. Firstly, because it is fuelled by insufficient demand and high unemployment in the eurozone (the desired outcome of the policies of internal devaluation pursued in recent years). Secondly, because it is dependent on other countries running equally large current account deficits. Traditionally the United States have played the role of ‘consumers of last resort’, but it is unrealistic to expect them – or anyone else – to be willing to go on absorbing European surpluses forever. To get a feeling of the American mood, I recommend reading this scathing critique of European neomercantilism that recently appeared in the Wall Street Journal.
To conclude, the last thing the eurozone needs is a further dose of quantitative easing. What it needs is a fiscal expansion aimed at boosting investment and demand through direct injections into the real economy, bypassing a broken financial sector. Quantitative easing for the people, if you like.