QE amounts to massive liquidity injections leading to an environment where cheap money is the norm. It is achieved through setting official rates low as well as implementing asset-buying plans aimed at pouring extensive liquidity into the financial system. It ultimately aims at driving borrowing costs downwards, thus invigorating credit and overall demand. The US experience has acted as a hallmark for QE, having achieved outstanding results in terms of growth and employment.
The ECB is securing unlimited access to fresh liquidity, keeping rates close to zero and providing medium-term finance earmarked for credit to the real economy. Moreover, it intends to implement a vast asset buying programme covering senior lending securities, as well as covered banking bonds. Up to now, results have failed to match expectations. The first tender target came up well short of the stated goal. The current covered bond plan has only reaped €4.8 billion. Loans have continued on a downward trend while price levels have ensured performance remains the same. Furthermore, the ABS buying programme being launched next month offers little hope, as it will only take off when new securities are issued.
Cheap money seems unable to redress the current shortcomings. Yet, no one should be surprised with such a disappointing outcome. As the European economy largely depends on banks for fundraising, low-interest rates fail to foster expansion to the same extent as in the US. Across the Atlantic, large capital markets- highly sensitive to the price of money- feed lower rates into increased lending and growth. Here, prudential considerations play a more prominent role. Banks are reluctant to engage in further lending as increased exposure leads to extensive prudential coverage. As it involves substantial costs in terms of idle capital resources, incentives for enlarging the credit portfolio fail to materialize.
Despite the vast amount of potential liquidity at hand, banks are refusing to turn these resources into fresh loans to enterprises and households. Refinancing is taking the lion’s share in a desperate attempt to reduce forbearances and the ensuing additional capital consumption. As credit institutions revert to defensive strategies, QE fails to reach the desired goal. Borrowers also feel less inclined to enlarge their exposure, as deleverage and a run for inner solvency sharply reduces their credit demand.
Thus, QE in Europe plays a far less prominent role than in the US. As Keynes vividly showed, monetary tools are unable to infuse enough stamina into overall demand if the liquidity trap checks efforts to increase disposable income. Thus, as Draghi rightly points out, the ECB seems utterly unable to redress the current sluggish economic performance on its own. Only a policy-mix combining fiscal flexibility and structural reforms can do the trick. The ball is back once again in the governments’ court.