The European Central Bank announced it will begin buying government bonds with newly printed euros in its latest bid to reverse the continent's long, slow slide into economic stagnation.
Specifically, the ECB will buy €60 billion, or $69 billion, of assets a month—including government, institutional and private sector bonds—and will do so until at least September 2016, or until there's a "sustained adjustment in the path of inflation" toward their close-to-but-below 2 percent goal. To give you an idea how far away that is, prices are actually falling in Europe—a seriously worrisome sign—with euro-zone inflation currently at -0.2 percent. It's no wonder that Europe's economy still has 11.5 percent unemployment and is growing so slowly that it's not clear whether it's even gotten out of its last recession. Hence, the ECB's €1.1 trillion, at the very least, promise.
This kind of open-ended commitment was a surprisingly strong one for an ECB Council that has faced histrionic opposition to any sort of governmental bond-buying from Germany and other northern European nations, which view it as little more than a backdoor bailout for the supposedly profligate crisis countries.
To fight that perception, the ECB will buy each country's bonds in proportion to its economy's size, and each country will bear most of the losses if it does default. The ECB itself will be on the hook only if some of the nongovernment bonds it buys, which make up 20 percent of the total, go bust.
In theory, this shouldn't really matter, since it would become an issue only if the euro were already breaking apart, but it could still blunt some of the benefits. If the crisis countries looked like they were back in acute, rather than chronic, distress, investors might demand higher interest rates on their debt, negating the ECB's actions, to compensate them for the fact that they'd have to take larger losses to try to keep the government from doing so. Still, this is only a hypothetical risk that's much less important than the reality of the ECB's substantial commitment.
As part of that, the ECB also introduced even more attractive terms on the cheap long-term loans it's offered banks to try to get them to start borrowing. In all, this package of low-cost loans and bond-buying, or quantitative easing (QE), was so much bigger than expected that the euro fell another 1 percent, down to $1.1475, against the dollar.
So will it work? Well, it can't hurt. Quantitative easing usually works, as economist Tony Yates explains, in ways that it won't in Europe. It pushes down borrowing costs, but those are already about as low as they can get across the continent. It lets corporations issue cheap bonds, but most European companies borrow from banks rather than capital markets. It signals that the central bank won't raise interest rates for a long time, since it's buying bonds instead, but nobody expected Europe, which is stuck in a depression worse than the 1930s, to do so anytime soon.
It also doesn't help that the ECB will be buying the most bonds from countries that don't need them, rather than from the ones that do. But that was the political compromise they had to make. Nonetheless, it should force people out of bonds and into, say, stocks, which should in turn boost markets and spending from people who feel richer, but that's not a big effect. The bigger one will be whether it can convince people that inflation really will start rising, which would do much more to get people spending and companies investing.
And finally, QE is a little bit of a bailout, but not in the way that Germany's afraid of. Think about it like this: When a country buys its own bonds with newly printed money, it doesn't have to pay interest on that debt anymore. Now it still does, but this is just an accounting fiction. It's moving money from your right hand to your left hand, and then back again to your right. That's because the government pays the central bank the interest that's owed on the bonds, but the central bank turns around and gives the government all the money it just got paid.
As economist Paul De Grauwe points out, this wipes out each country's interest payments, so it's not as if Germany is bailing out everyone else. They're all bailing themselves out in equal measure. And this matters a lot for a country such as Italy, which would be running a surplus if not for all the interest it owes on its debt. Those payments, together with its still-shrinking economy, are why Italy's debt burden has actually increased despite all its austerity. QE will help this.
But it might be too little too late. Or maybe too late too little. It's hard to tell in Europe.