Carlo Clericetti – The lesson of QE (which will not be questioned)

Quantitative easing, the ECB’s purchase of securities on the market, has ended and some conclusions can be drawn. It has certainly avoided the worst happening, but it cannot be said to have achieved the results it had claimed it would. Above all, it was a great empirical proof of the errors of the dominant economic theories

Carlo Clericetti is an Italian journalist. In the past he has directed “Affari & Finanza”, a weekly supplement published by “La Repubblica”, and web portals. Currently he  blogs for “La Repubblica”, for his personal website “Blogging in the wind”, and writes for other websites on economy and politics.

Cross-posted from MicroMega-online 

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Quantitative easing (QE), i.e. the extraordinary purchase of government and corporate bonds by the European Central Bank (ECB), has ended. Which conclusions can we draw from this?

Its effects on the economy have already been extensively discussed, and a brief summary can be made here. Little has been said, however – at least outside academia – about another consequence, of even greater importance, because it should lead to a reversal of European economic policies. Such a reversal is not happening and will not happen, nonetheless, for reasons that can be identified.

The stated aim of the QE was to restore a correct transmission of monetary policy, to avoid the dangers of deflation by stimulating the economy, and to bring inflation “below, but close to, 2%”: the latter point was perhaps considered to be the most important, given the mission entrusted to the ECB by its statute. Today, after three and a half years (QE began in March 2015), inflation is around that level in several Eurozone nations and was just 2% in average according to the latest data (July), although the so-called “core”, i.e. with the most volatile components removed to provide more accuracy (energy, fresh food, alcohol and tobacco) was only + 0.9%.

It is difficult to link QE with consumer prices. What it certainly achieved was to reduce the yields on government bonds, to the advantage of public budgets, which spent less to pay interests on debt. And of banks’ budgets, which on the one hand lightened the burden of public securities in the portfolio, and on the other hand recorded the price increase of those left in it. But the zero rates have reduced to insignificance the profits from the management of money. It was profitable, instead, for those who had to buy a home, because even mortgage rates have fallen to levels never seen before: despite this, there was no repetition of the real estate “bubbles” that happened in various countries before the crisis (lately there are signs of this in Germany). In Italy, on the contrary, the construction industry suffered seriously and has still not fully recovered.

The bubble, however, took place on stock markets, with the stock exchanges acheivng an all-time high. The fall in interest rates on government securities was also reflected in corporate bonds. The hugely high level of liquidity in circulation has gone in search of better returns than those of fixed income; moreover, the large corporations (especially the American ones) have used the savings obtained on loans for the notorious “buy backs”, the purchases of their own shares, which improve the financial indicators, but, also significantly raising the amount paid out in managers’ bonuses, usually linked to the stock exchange performance. Trump’s tax reform gave another boost to this process, since it is likely that a good part of the greater profits from tax savings will end up in buy-back.

Another positive effect was the weakening of the euro, which favoured exports, although an even stronger movement could have been expected, as U.S. rates started to rise again while head of the European Central Bank Mario Draghi declared that our rates would remain unchanged for a long time to come.

A negative aspect was instead the widening of the imbalances on the Target 2 payment system, as Draghi himself said, and then Vice President Vitor Constancio repeated.  ( )This was caused above all by the purchase of securities from outside the Eurozone being regulated through the Bundesbank, which was then selling them to the national central banks, increasing assets on the German balance sheet while increasing the liabilities for the others. This is something that in theory can have practical effects only in the event of an exit from the euro. However it also indicates an imbalance that does not depend, in this context, on economic trends but on a purely technical factor. And yet it offers the opportunity to some economists and opinion leaders to spread alarmist ideas, or even, in the most extreme cases, to ask to “settle the bill”.

But let us now come to the most important consequence of the QE: that of demolishing some fundamental pillars of the dominant economic theories, the ones used by those who dictate economic policies. The first pillar razed to the ground is the link between the amount of money and inflation. When the US Federal Reserve began its QE (well before the ECB) many economists soundeded the inflation alarm: within three to six months an radical increase in prices would be unleashed. Now, after a decade of all the major central banks (American, European, Japanese, English) flooding the world with liquidity,  notable price increases have not materialized anywhere, and we are currently threatened by deflation.

The second pillar is the claim that fiscal policy, which is carried out by tweaking the public budget, is useless and harmful, it does not serve to overcome crises and it causes harmful distortions to the economy. This really is an essentially European obsession, because the US, Japan and the UK, to name the most important nations, have expansionary fiscal policies. We don’t: the German “Rule”, imposed on the whole European Union, states that a balanced budget has absolute priority. Then, if the deficit is increased, another brilliant theory suggests, families and businesses will expect an ensuing tax increase to finance it; so families will save to pay this future tax, not fueling consumption, and businesses will not invest.

Some people point out that the European obsession has been attenuated with the introduction of the “output gap”, i.e. the difference between actual GDP and potential GDP. The concept claims that if a nation grows less than it should (i.e. less than the potential GDP) it gains more space for fiscal policy. But, the way of calculating this largely arbitrary potential, has sometimes resulted in evident absurdities. These are homeopathic spaces, totally insufficient to achieve results when a crisis is severe.

So how does the economy get back on track according to these neo-liberal economics? On the one hand, with the mythical “structural reforms”, which means above all reducing workers’ rights, increasing precariousness – pardon me, “flexibility” – lowering wages as much as possible; on the other hand, by stimulating the economic system. QE, purchasing securities from the banks, has increased their liquid reserves, and in addition it has come to establish a negative rate for these reserves, that is, the banks pay if they do not relend them (apart from what is necessary for their compulsory reserves). This should have pushed them to lend and companies should have used that money to invest, restarting the cycle. Theoretically perfect: too bad it didn’t work.

Why is that? Maybe because companies only invest if they think they can sell what they produce. But families, with stagnant or falling wages and high unemployment, all coupled with welfare cuts, have little to spend. And no help comes from sinking government expenditures, whose investments in Italy have fallen to a third of the pre-crisis period. Investing and producing to fill up warehouses? No, thank you.

There is more. Even the international banking regulations have taken their toll, considering loans to the real economy much more risky than financial investments. So, the banks that want to support the real economy have to raise more capital than those that play roulette in the markets. Congratulations to the regulators!

Now QE is coming to an end, just as already weak European growth is showing signs of slowing down. QE buffered the problems, but it did not solve them. Has anyone questioned the effectiveness of the years of QE? No, just as they never questioned the EU and Euro policies, although these have been such failures, driving the peoples of the European Union apart and not together. Such policies do not aim to improve the lot of as many people as possible, but to create a competitive society where some prosper, and most others do not: at most they will be kept quiet with some subsidy that will help them survive, and they will also have to say thank you. That’s the “social market economy”, baby!

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