Jean Pisani Ferry writes: Eurozone monetary officials are expected to make history when they gather for the European Central Bank\u2019s next policy-setting meeting on January 22.<\/p>\n
The ECB has many reasons to launch QE.\u00a0 Low inflation is already a serious obstacle to economic recovery and rebalancing within the eurozone. Outright deflation would be an even more dangerous threat.<\/p>\n
Financial markets consider QE so likely that the largest part of its bond-rate and exchange-rate consequences have already been priced in. Should the ECB not launch QE,\u00a0 markets would confront an abrupt and damaging unwinding of positions: long-term interest rates would rise, stock markets would sink, and the exchange rate would appreciate. That is not what Europe needs as it struggles.<\/p>\n
Jens Weidmann, the president of the German Bundesbank argues that the consequences of recent price data may be less serious than believed, while those of full-fledged QE could be more serious than assumed.\u00a0 At a time when the US data seem to validate the Federal Reserve\u2019s strategy, why is the ECB hesitating?<\/p>\n
The Bundesbank fiercely opposed the ECB\u2019s conditional support of debt-distressed eurozone members, but German officials do not dispute the legitimacy of wholesale bond purchases for monetary-policy purposes.<\/p>\n
In principle, QE has nothing to do with sovereign solvency. It is a monetary instrument that the central bank must rely on when its policy interest rate has hit the zero lower bound and thus cannot be pushed lower.<\/p>\n
But, by lowering long-term interest rates, central-bank purchases of government debt can help contain government debt service. In this way, QE can keep solvent a government that otherwise would be insolvent.<\/p>\n
Japan is a case in point. The Bank of Japan already holds government securities worth 40% of GDP, and it is committed to annual purchases worth 16% of GDP.\u00a0\u00a0 With annual purchases amounting to twice the deficit, it has become hard to speak of a \u201cmarket\u201d for government debt. In fact, the BOJ sets the price.<\/p>\n
Such a situation can make the central bank hostage to the government\u2019s behavior. The BOJ\u2019s action is predicated on Abe\u2019s commitment to restoring the sustainability of public finances once deflation has been defeated and the economy has returned to growth. Should Abe fail to deliver, the BOJ would be trapped. If it stopped buying government debt, it could trigger a sovereign crisis and reduce the value of its own portfolio.\u00a0 But continuing its purchases would tighten the government\u2019s grip.<\/p>\n
Trust in the government is therefore vital for any central bank that embarks on QE. The EU fiscal framework lacks credibility and does not give the ECB confidence that governments will continue to pursue sustainability after its bond purchases shelter them from market pressure even further.<\/p>\n
Moreover, unlike its counterparts, the ECB does not face a single interlocutor. This explains why the ECB, once obsessed with the risk that governments would coalesce to assail its independence, has turned into the staunchest advocate of fiscal-policy coordination.<\/p>\n
These concerns do not diminish the need for bold unconventional action against deflation, and it should not prevent the ECB from launching QE. The parallel with Japan highlights the need for governments to behave responsibly, individually and collectively. Europe\u2019s elected national leaders have a large role to play, and they must not eschew their duties. The more confidence they give to the ECB, the more effective QE will be.<\/p>\n
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