The Fallacy of Quantitative Easing

There is no doubt the EU project has benefited the German economy above all else: a bit like the cat got all the cream and then some. But it cannot be put off any longer; as Voltaire once said, with great power comes great responsibility. In an unusual act of defiance against German apprehension to the ECB’s sovereign bond-buying programme, the ECB will press ahead with QE1. There will be a week to thrash out the exact details after the ECJ verdict on 14th January on the legality of such a move, but a formal announcement is expected on 22nd January.

The decision to “press the button” is more likely now than ever before given the falling prices in the Eurozone. Some would argue that we are being too quick to diagnose a deflationary spiral: that these are just temporary falls in prices. The truth is that falling prices were evident in the Eurozone long before the recent external (oil) supply shock took effect. Europe’s problems run much deeper.

In the short term, any announcement in QE is unlikely to be large enough or make a significant impact on economic fundamentals: much like plugging holes in a leaking dam. QE will only act as a plaster over the real structural differences that besiege the Eurozone. Indeed, some of the world’s major economies have implemented QE with dubious results: the USA has been through three rounds of QE with more favourable outcomes, however, whether that’s purely down to QE or other more dynamic variables has yet to be proven. The UK has gone through two rounds: with the first being more effective than the second. Japan on the other hand has had to endure NINE rounds of injections (yes, QE9!) with little effect. Even after 20+ years, the legacy of deflation is engrained and growth remains elusive.

In the more medium term, what is clear is that QE will contribute to bloating banks’ balance sheets, with little in the way of affecting the real economy. This is unlikely to prompt banks to lend more. On the contrary, the winners of QE will be the bond holders, mostly the well-off, whom are unlikely to spread to the gains evenly around the economy, but would rather pile into assets thus further perpetuating asset price inflation. It’s an inefficient allocation of resources: the “wrong” people are being targeted.

What else if not QE one might ask? Recent reports suggest that Japan is toying with the idea of implementing a more innovative monetary policy tool known as “helicopter money”: dropping money directly into the pockets of every citizen. Whilst this would target the “right” people, it may all be too radical for the bureaucrats of Europe. Many economists view this measure with great suspicion partly because it hasn’t been tested robustly enough. However, the belief that prices will fall further may already be entrenched into the minds of EU citizen, so any windfall in the way of helicopter money (if too small) may be squirrelled away rather than spent on stimulating the local economy. Introducing a voucher- based system for certain goods and services is marginally better, but this too comes with a host of complications in terms of which good and services qualify, and ensuring money is not leaked out of the system.
It will need more than QE to resuscitate the Eurozone. A Eurozone break up is out of the question no matter how necessary it may be in economic terms: politics will trump economics. What is more likely is that there will be QE-light – but this still falls short of what is really needed: further structural reforms and deeper fiscal consolidation. One thing is for sure: being timid never got anyone anywhere…


The Fallacy of Quantitative Easing  |  Author  |  Shefali Enaker  |  Economist