Quantitative easing (QE) has become the European Central Bank’s (ECB) primary tactic to inject the stagnant European economy with liquidity and save the deflating Euro. Proponents of QE argue it provides a favourable investment environment because it is a liberal fiscal policy that drives down interest rates and spurs spending and investment.
The overall goal of QE is to achieve long-term growth in the European Union (EU). However, the decisions surrounding QE have not been easy, partly because the Eurozone differs in normative political and economic theory. To quote The Economist, “a big bond-buying programme is tricky in a monetary union where there is not one federal government but 19 national ones, of widely varying credit worthiness, ranging from triple-A for Germany’s to junk for Greece’s.”
A Brief History
Facing a declining economy and allegations of a “failed union,” the European Union announced its widespread asset buying program called quantitative easing in January 2015. The program will continue until at least September 2016. The 1.1 trillion euro project involves buying securities and public debt issuances. Alongside QE, the European Central Bank offers extremely low financing rates to member banks.
The Debate: Correlation Is Not Causation
Germany, known for its government’s fiscal conservatism, is the antagonist against QE proponents. In the initial QE discussions, Eurozone members had to give leeway to Germany by giving the Bundesbank, Germany’s equivalent to the U.S. Federal Reserve, an arguably larger role in comparison to other EU countries.
Political opponents fear QE provides a disincentive for member states to restructure and step up to the plate, while allowing for the “stronger” countries to take on the burden of debt-ridden members such as Greece and Italy.
Apart from the political debate, there’s economists’ skepticism of whether or not QE can solve the EU’s financial problems. Bloomberg QuickTake notes concerns that QE “fuels asset bubbles as the money flows into stocks and other assets instead of benefiting companies and households.”
Does QE actually bring about investment? Ralf Thomas, Siemens Chief Financial Officer, thinks not. According to the Financial Times, Thomas says that when making investment decisions, businesses take into consideration factors other than loan interest rates. Instead, they compare forecasted earnings with the weighted average cost of capital (WACC). This includes the cost of equity through returns to shareholders and the cost of debt through interest rates. As the cost of debt decreases, equity financing usually increases in relation to a high equity-risk premium, leaving the weighted average cost of capital nearly unchanged. QE may be more futile than anticipated if business leaders and investors, in fact, choose to put substantially more weight on considerations such as WACC, barriers to entry and industry growth prospects than cost of debt financing.
Nonetheless, modest increases in investment in the EU encourage QE advocates, as the program will continue to keep debt financing low. Believers in QE say that easy access to credit has “trickled down” the economic food chain in depressed countries. If enough information shows “success,” the EU may look to revamp the asset buying program in 2016. According to BBC News, this looks likely, due to modest EU economic growth, the decreasing cost of oil, and positive ECB projections for future growth rates at 1.4% in 2015 and 1.7% in 2016.
The Bottom Line
European Central Bank president, Mario Draghi declared that the bank will “do whatever it takes” to aid the stagnant Eurozone economy and save the devalued euro. Proponents of quantitative easing now consider reinvigorating the program to make new money by buying more securities, mainly government bonds. The debate circles around political arguments and the economic capacity of the program to bring about substantial change in the EU. More fiscally conservative governments, such as Germany, better hope that this asset buying helps the crisis. If not, they will likely attempt to renegotiate or simply pack their bags and re-evaluate their Union ties.