Debate on ECB’s Stimulus Continues

ECB Quantitative Easing

All eyes are on the ECB’s Governing Council meeting scheduled next week in Frankfurt. It will be a crucial meeting on monetary policy. The market believes the ECB might announce a bond buying program to stimulate the euro zone’s limp economy. The Governing Council will decide how best to stave off a deflationary spiral in the Euro zone, the single currency zone of 19 countries (On 1 January 2015, Lithuania became the 19th member).

Though it is not likely to be a unanimous decision, the ECB appears ready to launch quantitative easing (QE). Quantitative Easing (QE) is a unique monetary policy used by a central bank to stimulate the economy. The central bank injects funds into the economy through the purchase of government and mortgage securities. Around one-third of the 25 Governing Council members are reported to be against QE. Moreover, it is not clear what exactly this policy would consist of. The public debate over stimulus package is at a peak this week.

In September, the European Central Bank had surprised the market with Rate Cuts to new record lows. It slashed all its main interest rates by 10 basis points and announced two new stimulus programs to push money into the flagging euro zone economy. The ECB would buy Asset Back Securities (ABS) and covered bonds. The announcements exceeded even analysts’ expectations.

However, the measures adopted so far such as cheaper credit, or measures to support lending proved to be insufficient.  Lower rates could not stimulate investment and growth. Inflation entered negative territory at -0.2 percent in December, the first decline in more than five years. This is in contrast to the ECB’s desired level of 2%.  Very low inflation could persist longer and threaten the currency area’s economic recovery.  Euro zone GDP growth faltered in Q4. The euro zone economy ended 2014 with its worst quarter for over a year, raising fears of a triple-dip recession.

The stimulus package is needed to help investment and growth at a time when the economy of Euro zone has stalled. Quantitative Easing increases money supply.  Money printing is inflationary and raises expected inflation and thus prices of all assets including houses started moves up. It stimulates consumption and growth.

The measures open to the ECB is the purchase of assets. Sources report the amount could be 500 billion euros ($593 billion) over three years. But the issue is what type of assets, whether government debt or corporate bonds. The second question is who carries the risk of default.  It has to decide whether there would be a risk sharing among the euro zone’s members or if individual member states would carry the risk of its own central bank’s purchases.

The ECB’s stimulus would aim to prevent economy slide into deflation. Despite these measures, the ECB alone cannot save the Eurozone economy and needs fiscal measures from the governments of member states.

Author Bio Photo
 kanchanThe author, Kanchan Kumar, is an MBA in Finance and MS in Statistics and has served as Executive Director and Advisor with several multinational companies, Financial Institutions and Universities.  He writes on Global Economy, Market and Personal Finance.

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