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Mario Draghi’s Bombshell Is Europe’s Last, Best Hope to Return to Growth Fear That Eurozone Stimulus May Be Too Little or Too Late
(about 2 hours later)
The program to try to jolt the European economy out of its doldrums that Mario Draghi unveiled Thursday is several months late, timid compared with its counterparts in the United States and Japan, and full of complexity aimed at satisfying his political constituents. The European Central Bank unleashed a surprisingly aggressive stimulus plan on Thursday that looked like the last, best hope to prevent the region from sliding toward another lost economic decade with the stagnant growth, high unemployment and political strains that it would mean.
It may also be the last, best hope to prevent Western Europe from sliding toward another lost economic decade, with the high unemployment and geopolitical strains that would imply. But the 1.1 trillion-euro question is whether the bond-buying program will jolt Europe out of its economic doldrums or merely create a short-term lift to financial markets. The flood of new money sloshing around the global economy could also create problems elsewhere.
The program is bigger than analysts were expecting, and its details show a commitment by the E.C.B. not to bend to political pressure (particularly from Germany) to hold its fire for fear of the monetary authority subsidizing reckless borrowing by Southern European countries. The action was enough to drive European stocks up and the euro currency down, just the market reaction that Mr. Draghi was surely hoping for. “The E.C.B. will succeed in weakening the euro and maintaining generally low interest rates,” said Mohamed A. El-Erian, the chief economic adviser at the financial services company Allianz. “But this is insufficient to deliver a growth breakthrough,” he added, and “comes with the risk of collateral damage and unintended consequences.”
There’s no question that Mr. Draghi showed guile and savvy in guiding a fractious committee of central bankers to a bigger and more aggressive program than seemed plausible even a few weeks ago. The trillion-euro question is whether it will be enough, and that’s where the finer details come into play. The program’s success or failure will depend on whether the compromises needed to gain agreement will prove minor enough not to undermine its goals — and whether they have succeeded in shocking decision makers across Europe into a belief that it is riskier to hoard money than to spend and invest it. Since the financial crisis in 2008, nations grappling with economic weakness have repeatedly turned to one tool to try to fix things: the power of their central banks to create new money from thin air and push it into the financial system by buying bonds. Such programs, known as quantitative easing, can help lower long-term interest rates and bolster financial markets, encouraging spending and business investment.
Mr. Draghi, the president of the European Central Bank, announced plans to buy 60 billion euros’ worth of bonds per month through at least September 2016, which would imply 1.1 trillion euros ($1.3 trillion) in new money injected into the European financial system. The plan is to continue until the central bank’s leaders judge that inflation is returning toward the goal of below but close to 2 percent. For the year ended in December, prices actually fell 0.2 percent in the 19 countries using the euro currency. Years after the United States, Britain and Japan traveled down that path, the European Union, long hamstrung by the complex politics of a single central bank setting policy for 19 countries, has developed its own program. The E.C.B. will buy 60 billion euros worth of securities a month, the bank’s president, Mario Draghi, said, including both government bonds and private sector assets. With prices falling in the countries using the euro, Mr. Draghi pledged that the purchases would “be conducted until we see a sustained adjustment in the path of inflation” to become more consistent with the central bank’s aim of inflation just below 2 percent a year.
At first glance, Mr. Draghi’s plan emulates the Federal Reserve’s QE3 program: the third round of quantitative easing, or bond buying, announced in the United States in September 2012 and which most likely helped the acceleration in the American economy over the last two years. Both programs were open-ended in size, with billions in monthly bond purchases paired with a pledge to continue until some goal is met (for the Fed, it was substantial improvement in the job market, for the European Central Bank, returning inflation toward its target). The program was bigger than analysts had expected, and the initial market reaction was favorable. Stocks jumped worldwide, and borrowing costs fell, particularly in Europe. The value of the euro — already dropping precipitously in recent months in anticipation of the move on Thursday — dropped an additional 2 percent against the dollar to its lowest level since 2003. That should help the E.C.B’s goal of increasing eurozone inflation, and help make the Continent’s exporters more competitive.
The success or failure of the program, though, depends on much more than one day’s market moves. And the mixed record of monetary injections elsewhere show the challenges that Mr. Draghi and his colleagues will have turning their fiscal activism into sustained economic improvement. The American and British efforts are generally considered successful, but Japan is struggling with a weak economy and deflation.
Mr. Draghi acknowledged that it would take more than an open spigot of money from the central bank to get Europe’s economy on track, and that political authorities across Europe must act as well. “What monetary policy can do is to create the basis for growth,” he said at a news conference in Frankfurt. “But for growth to pick up, you need investment. For investment, you need confidence. And for confidence, you need structural reforms.”
“It’s now up to the governments to implement these structural reforms,” he said.
Then there are the broader risks of such aggressive monetary activism, as trillions of new dollars, pounds and yen have created unpredictable ripple effects worldwide. Even before Europe announced its plans, risks started to surface.
Switzerland’s central bank last week abandoned a longstanding peg of the value of its currency, the franc, against the euro, concluding that it would be impossible to maintain amid the anticipated E.C.B. action. After dropping the cap, the value of the franc rose 17 percent in a single day, and a Swiss recession may well result.
Also Thursday, the Danish central bank cut interest rates, as it faces the challenge of maintaining its own peg between the krone and the euro. It is the country’s second rate cut in a week.
Going in the opposite direction, the Federal Reserve is withdrawing its extraordinary stimulus from the United States, helping to drive up the value of the dollar on global currency markets. That could make for more challenging times for American exporters and companies and banks in emerging markets that have borrowed extensively in dollars.
Even as the ripples from years of monetary intervention spread through the globe, the biggest uncertainty for Europe is whether the new program will be enough to arrest a slide toward deflation. Analysts have been reluctant to predict too much out of the new program.
“Q.E. is not a silver bullet for the eurozone’s many problems,” Howard Archer, the chief European economist for IHS Global Insight, wrote in a research note. “But it should provide some limited help to growth by adding to the stimulus that is already coming from very low oil prices and the markedly weaker euro.”
At first glance, Mr. Draghi’s plan emulates the Federal Reserve’s third and final round of quantitative easing, which is generally credited with helping to accelerate the American economy over the last two years. Both programs were open-ended in size, with billions in monthly bond purchases paired with a pledge to continue until some goal was met. (For the Fed, it was substantial improvement in the job market. For the European Central Bank, returning inflation toward its target).
There are two big differences.There are two big differences.
First, it is late. When the Fed pulled the trigger on its open-ended bond buying, in 2012, annual inflation was running at 1.6 percent in the United States, not far below its 2 percent target. The economy was growing at a steady if unexceptional rate. The Fed was looking to get ahead of its problem of sluggish growth. First, the E.C.B. is late. When the Fed pulled the trigger on its open-ended bond buying, in September 2012, annual inflation was running at 1.6 percent in the United States, not far below its 2 percent target. The economy was growing at a steady if unexceptional rate. The Fed was looking to get ahead of its problem of sluggish growth.
The European Central Bank, by contrast, has spent the last two and a half years seemingly looking for any excuse not to take the action announced Thursday, with a series of half-measures. The difference has its roots in differing economic analysis about the dangers of deflation and complex political factors, in particular the aversion of Europe’s central bankers and German political leaders to use the common central bank to share risk among different countries. The European Central Bank, by contrast, has begun a series of half-measures over the last two and a half years. The contrast has its roots in differing economic analysis about the dangers of deflation and political factors, in particular the aversion of Europe’s central bankers and German political leaders to use the common central bank to share risk among countries.
The second big difference with the American program is that the E.C.B. is only dabbling with risk-sharing across Europe. The second big difference with the American program is that the E.C.B. is moving only partway in distributing the risk of losses across the countries that use the euro.
The European Central Bank in Frankfurt administers its policies through national central banks across the eurozone: the Bundesbank in Germany, the Banca d’Italia in Italy, and so on. A big question has been whether any losses due to government defaults or restructurings on bonds bought through this quantitative easing program would be borne by Europe as a whole or the specific national bank that bought the bonds. The European Central Bank, which is based in Frankfurt, administers its policies through national central banks across the eurozone: the Bundesbank in Germany, the Banca d’Italia in Italy, and so on. One debate Mr. Draghi and his colleagues had to resolve was whether any losses from government defaults or restructurings on bonds bought through this program would be borne by Europe as a whole or the specific national bank that bought the bonds.
The German government would strongly prefer the risks stay on national books. Why, they reason, should Germany’s central bank pay the bill if Portugal defaults on its obligations? Mr. Draghi was dismissive of the importance of this so-called risk mutualization debate in his news conference Thursday. But the plan he unveiled showed the hallmarks of an intricate negotiation to have some elements of risk-sharing and some risk remaining on the books of individual national bank.
The problem is that doing this eliminates one of the crucial ways that a central bank can act as guarantor of a nation’s economy. The European Central Bank isn’t much of a lender of last resort if each country within the eurozone is on its own when things turn bad. It would be as if the Federal Reserve system as a whole had refused to stand behind the Federal Reserve Bank of Atlanta when it was making emergency loans to failing banks in Florida during the financial crisis; part of the strength of the system is that the entirety of the United States government, and its central bank, stood behind each component part. Mr. Draghi showed guile and savvy in guiding a fractious committee of central bankers to a bigger and more aggressive program than seemed plausible even a few weeks ago. But those compromises, if they are too significant, may undermine his goals, failing to shock decision makers across Europe into a belief that it is riskier to hoard money than to spend and invest it.
Mr. Draghi was dismissive of the importance of this risk mutualization debate in his news conference Thursday, but the plan he unveiled shows the hallmarks of an intricate negotiation to have some elements of risk sharing and some risk remaining on the books of individual national banks. “I am not sure this is a game changer,” Gary D. Cohn, the president of Goldman Sachs, said at the World Economic Forum in Davos, Switzerland. “Monetary policy in itself is one ingredient, not the ultimate solution.”
For nearly eight years, since the first tremors of what would become the global financial crisis were felt, global central banks have been the first responders, for better and worse, to a rolling series of panics and disappointing economic results. (The better: They have often moved more decisively and powerfully than elected officials. The worse: Their tools are often ill-suited for the challenges their economies have faced, and created dangerous ripple effects).
Mr. Draghi’s move is firmly within this tradition. We don’t know how it will end, only that he has shown the determination to recognize that the status quo, for Europe and the world, was no good.