The European Central Bank embraces quantitative easing despite the sorry track record of ‘helicopter money.’
Central banks in the U.S., Japan and Europe are trapped in a loop. They are fully invested in the theory that zero rates and bond buying are stimulative and add to inflation, yet growth, inflation and median incomes keep going down.
On Thursday the European Central Bank is likely to announce a bond-buying binge that could reach €50 billion ($58 billion) a month, yet many bond yields in Europe are already negative. Buying low-yielding bonds is a dead end for growth. The Bank of Japan has already bought bonds worth more than 50% of its gross domestic product with no growth impact. And ECB bond-buying will be a major new political negative if it gives European governments a further excuse to avoid economic reforms.
Central bankers should be forcefully urging their governments to pursue practical growth-oriented solutions that encourage private investment and hiring. Instead, they’ve allowed the focus to be on them and their decisions to prolong quantitative easing—even though QE hasn’t worked.
Central-bank liabilities have grown by an extraordinary $7 trillion since the 2008 crisis, yet many parts of the world are in or near recession, including Japan, Latin America, Eastern Europe and most of the eurozone. The World Bank and International Monetary Fund have just lowered their 2015 global growth forecasts, and the IMF is expected to knock more than $5 trillion off its October estimate of 2015 world GDP due to recent declines in commodities and currencies and the slide toward deflation.
Central bankers apparently believe deflation can still be halted by what Milton Friedman called a “helicopter drop” of money, but it isn’t clear they have the right tools. Bank reserves are already in massive excess. Adding more, as the ECB is expected to do, won’t add growth or stop the price declines because there’s no longer any link from central-bank reserves to private-sector money. To “helicopter” money into private enterprises would require regulators giving a green light to banks to take on more leverage (unlikely given past bank errors) or central banks taking on credit risk, not a wise course.
A better approach would be growth the old-fashioned way through robust after-tax profits at small businesses, investment in startups and more jobs. In most of the developed world, that kind of growth has been on hold, waiting to find a path through regulatory obstacles.
The risk, as inflation rates fall into negative territory, is that central banks will double down on their current set of ineffective policies, making matters worse and allowing recessions and deflation to spread. The U.S. consumer-price index fell 0.4% in December and is on track for another large decline in January. As a result, the Federal Reserve is sending signals that it may delay rate hikes, though six years of near-zero rates haven’t produced satisfactory growth or price stability.
These signals are self-defeating. If the public sees prices declining and senses further delay in interest-rate hikes, why buy a house or business now? The same reluctance to change policy stalled the Fed’s 2013 plan to taper its bond purchases, but when the Fed finally moved forward a year ago, bank lending and growth surged.
Near-zero rates channel credit to the safest borrowers—the government, corporations and the wealthy—at the expense of small savers, small businesses and median incomes. In a market system, credit is allocated based on the price of credit and the riskiness of the borrower.
In our current system, however, the government is setting the price through zero rates and bond buying. It’s also controlling the amount of bank credit through regulatory policy and leverage standards. The result is a channeling of credit to the safest borrowers, which are seldom the best job creators. Even some banks get crowded out because the zero-rate policy has put the interbank market into a deep freeze—there’s less reason for one bank to lend to another with rates this low.
The ECB is facing its own low-rate trap. To make up for antigrowth government policies, the ECB pushed interest rates below zero, creating new problems for growth and lending. It’s now planning to buy low-yielding government bonds, offering the sellers a bank deposit at the ECB that pays a negative interest rate. With bank leverage controlled by regulators, the banks won’t have more assets but simply a different, less growth-oriented mix of assets that includes fewer loans to small businesses and more deposits at the ECB. To fund the Fed’s QE, the U.S. banking system has had to devote nearly 20% of total bank assets to the Fed’s bond purchases, mostly at the expense of other lending.
Forcing Europe’s bank assets to pass through the ECB into government bonds can’t restore Europe’s growth, especially with many bond yields already negative. Observing these problems, Switzerland last week broke its three-year alliance with the eurozone. The Swiss National Ban k had been buying large quantities of euro-denominated assets—stocks, bonds and bills—as needed to keep the Swiss franc linked to the euro. That made sense in 2011-13 when it seemed that Germany and the ECB were working together to promote structural reforms that might repair Europe’s economy and maintain the euro’s value.
But the ECB is now using QE to promote the devaluation of the euro as a way to make up for Europe’s uncompetitive tax and regulatory policies, much like the Bank of Japan has done with the yen without causing growth. Germany’s representatives on the ECB board may vote against the ECB’s bond-buying scheme and have challenged its usefulness, concerns that made Switzerland uncomfortable investing more in the euro.
To his credit, ECB President Mario Draghi has been vocal about the need for governments to reduce both spending and taxes. It would go a long way toward quelling deflation fears and restoring Europe’s growth if he used bond buying to gain structural reforms rather than merely following Japan’s lead into no-growth QE.
Mr. Malpass is president of Encima Global LLC. He served as deputy assistant Treasury secretary in the Reagan administration and deputy assistant secretary of state in the George H.W. Bush administration.
