No convincing strategy for QE withdrawal has yet been put forward says Bill Jamieson
TWO cheers for the International Monetary Fund: its latest forecast for the UK economy projects growth of 2.9 per cent this year, up from its estimate of 2.4 per cent in January – its second such forecast upgrade for the UK.
It came with an admission by IMF chief economist Olivier Blanchard last week that it had clearly underestimated UK growth: “It is fair to say our forecast was too pessimistic,” he said.
However, far less encouraging was its assessment for the Eurozone economies, coupled with a grim warning that deflation could cripple the Euro economies and cast a pall over global recovery. This doubly matters for us because the Euro area is a critical theatre for UK exports and we have a chronic balance of payments deficit to address.
Last week, the IMF declared that deflation was the biggest risk to recovery in the euro area and that it needs more monetary easing – including unconventional measures, such as quantitative easing (QE) – to sustain recovery and reach the European Central Bank’s inflation target of 2 per cent. IMF managing director Christine Lagarde has urged the ECB to effectively print more money to head off the deflation risk.
Its latest forecast is for growth in the euro area of just 1.2 per cent this year, following negative growth of 0.5 per cent last year. This compares with predictions of global growth of 3.6 per cent this year and 3.9 per cent in 2015.
But its call on the ECB to embark on monetary stimulus received a sharp rebuff from bank president Mario Draghi last week. The bank continues a teasing Dance of the Seven Veils, saying that it has not ruled out such stimulus – but holding back from action. So much for his declaration two years ago that he would do “whatever it takes” to stave off the Eurozone crisis. So why this hesitation?
Few prospects are worse for the Eurozone than a prolonged period of Japan-style stagnation, the economy barely ticking over as banks are crippled by huge levels of bad debt and households and businesses are averse to stepping up spending. High unemployment persists in many of the Eurozone member states (above 25 per cent in Greece and Spain) and with worries about deflation, the problems in the banking sector and the continued need for austerity, it would be premature to assume that the Eurozone’s difficulties are behind it.
And the spectre of deflation looms closer. The fall in March’s inflation rate to 0.5 per cent sparked fresh calls for ECB action. Draghi said that the ECB’s governing council is unanimous in its commitment to also using “unconventional instruments”. However, there was no indication of the possible timing of any QE. And Draghi also refused to give details as to how it might work. The Bank’s Council could wait some months before any further loosening of policy.
The argument for waiting (and waiting) is that, except in the Eurozone periphery, incomes are rising faster than prices and the risks of deflation may prove overstated. In Germany, for example, there has recently been a far from deflationary, and above-inflation, pay settlement between German public sector workers and their government employers. The deal, which covers 2.1 million workers, granted a 3 per cent wage increase backdated to 1 March, with a further 2.4 per cent next year.
And according to a leaked ECB internal assessment of QE, the central bank would need to buy assets worth ¤1 trillion of purchases of euro-denominated securities (or ¤80bn a month) to lift inflation by as little as a fifth of a percentage point. This adds to the suspicion that the ECB remains doubtful about the efficacy of QE and suspicious of taking radical QE action.
Draghi’s rebuff to the IMF last week may have been spurred by a need to guard the sovereignty of the central bank. Or it may be that he does not share the urge to activism demonstrated across the Atlantic.
There is a respectable case for scepticism over the efficacy of cheap money schemes. For five years, the response of central banks in the developed world to sub-normal growth rates has been to devise programmes aimed at delivering more monetary stimulus. When these schemes have yielded disappointing results, central bankers have argued that things would have been a lot worse without them and, egged on by market traders keen to enjoy a ride on rising asset values, have sought fresh ways of delivering cheap money.
Then again, there may have been too much of a rush to judgment on the benefits of QE and a readiness to assume that its withdrawal could be effected smoothly and without risk to the underlying economies. Indeed, no convincing strategy for QE withdrawal has yet been put forward in the US or the UK. And the longer our reliance on it, the more it takes on the toxic dynamics of an addictive drug: we can only sustain a feeling of wellbeing by increasing resort to it.
Far from being followed by a retreat from excessive financial risk-taking, the danger is that such highly experimental policies have numbed our sensitivity to risk, an outcome likely to contribute to resource misallocations and ultimately to undermining the functioning of markets.
In any event, for the Eurozone as a whole, the scope for such stimulus looks limited. Monetary easing would probably have scant effect in boosting consumer prices. The ability of banks to expand lending is constrained and little by way of improvement can be expected until this is fixed. The Eurozone needs more than a wave of the IMF’s magic wand. «