“Austerity, not lack of liquidity, is what is causing the Eurozone depression”



– You’ve written that all QE does is substitute one asset for another. How did you perceive the European QE?


Here in the UK, European QE is generally regarded positively: as the EU is by far our largest trading partner, the depression in the Eurozone creates substantial risks for the UK, so any policies to counter deflation and promote growth are welcome. However, it’s not all good: we face a worsening balance of payments position because of the weakening Euro. And there is a widespread view that QE is too little and far too late.


– Do you think it will be enough to achieve the ECB’s 2pc inflation target?  Anyway, I find interesting when you, contrarily to Krugman, insist that deliberately raising inflation will not magically restore output. What should European authorities do instead on injecting liquidity in the system?


The last few years – decade if you include Japan – has demonstrated pretty conclusively that QE does not return deflationary economies to target inflation. And the experience of the UK 2010-12 showed that higher inflation does not necessarily mean higher output. The stagflation of the 1970s was high inflation combined with low output. And Keynes, writing in 1933, observed that higher inflation would not necessarily mean higher output. We know all this. Why are we trying to pretend this time is different?


QE does arrest a deflationary slide, because it supports asset prices, but that is all it does. When combined with excessively tight fiscal policy, QE may actually contribute to deflation because it slows the velocity of money. The system is already awash with liquidity. It doesn’t need more. What is needed is better distribution (so that money reaches the people most likely to spend it) and a generally looser fiscal stance across the Eurozone. Austerity, not lack of liquidity, is what is causing the Eurozone depression.



– Has the ECB compromised by putting the main responsibility of sovereign bond buying on national central banks’ shoulders?


Yes. It was a sop to those who think that national risks should be borne by national governments. And it runs directly counter to Draghi’s argument that the Eurozone must move towards more risk-sharing, not less. Clearly he agreed to it because the alternative was no QE, but it is far from ideal from the ECB’s point of view.


– Do you believe financial fragmentation in the EU can be an obstacle for Draghi’s QE getting to the real economy?


Yes, although the use of NCBs does bypass this to some extent. But interest rates on lending to businesses in the periphery remain elevated and I can’t see QE making much difference to this.


-As you know, European lenders did not show much interest in targeted LTROs (they borrowed half of the expected amount). Can this also happen with sovereing bond purchases?


No. Institutional investors will sell to the ECB, simply because it is not in their interests not to do so. Cash, after all, is a perfect substitute for sovereign bonds – indeed it is better since it has no term premium and, in the Eurozone, no sovereign risk.


– Paul De Grauwe and Yuemei Ji have argued that QE can occur in the Eurozone without fiscal transfers. What do you think?


It can, and indeed this is very nearly what is being done. If a NCB buys the bonds of its own government, and is in turn backed by its own government, there is no risk sharing and therefore no fiscal transfers.


– In the US, the 3 QE injections benefited more the stock market than the real economy. Do you expect the European QE to have the same effect?


Yes, the stock market will benefit. And QE will weaken the currency, too, which will help businesses exporting beyond the Eurozone (though not intra-Eurozone exporters). I don’t expect QE to have much effect on domestic demand, and it certainly won’t end the periphery depression.


– Is it really time for the Fed to raise rates or should we continue to “be patient”?


There is no justification for raising rates while core inflation is below target and wage growth remains flat. The US is facing deflationary headwinds at the moment, so raising rates would seem premature.


– Inflation in the US continues to run below the Fed’s 2% objective, the same in case of the ECB. Are central banks’ mandates just unrealistic or they are simply choosing not to do their job?


I am sceptical about central banks’ ability to hit an inflation target when fiscal policy is unsupportive and there are global pressures pushing in the opposite direction. Central banks are not omnipotent and we are expecting far too much of them.


-Should there be a coordination between countries as we saw in the 80s with the Louvre and Plaza accords?


Since we have currency wars in the Far East and in Europe at the moment, there is a case for some kind of agreement. But the real problem is the current fashion for fiscal hairshirts and mercantilism. When everyone is trying to balance their budgets by squeezing domestic demand, no-one can.


-In the graph (please find it attached): Given that governments don’t believe in fiscal policy is there any possiblity of monetary policy coordination to avoid markets’ volatility?


I’m a big fan of cooperation between central banks. They are major players in the world’s markets and their actions have enormous effects. When one large central bank acts unilaterally, the spillover effects to other parts of the world can be considerable. And competition between them causes currency and trade distortions that can have devastating effects. They really must start acting in a more coordinated fashion.


– You are a specialist in finance and risk managing. After the crisis the banking sector was asked to do a lot of cleanup but it seems that excesses have moved off the books and one again are growing to huge proportions.


When you ask a bank to clean up its balance sheet, it either sells its riskiest assets or it puts them in a dark corner. This is understandable, but all it does is move the risks out of sight. And it is the risks we can’t see that are really dangerous. Banks and financial institutions should be accepting and managing risk ON their balance sheets, not sweeping it under the carpet to please regulators obsessed with avoiding rather than managing risk. Risk aversion is toxic.


– The IMF warns that shadow banking now poses top risk to US stability. Is that a necessary evil to finally split commercial and investment banking areas?


As splitting commercial and investment banking would actually mean even more activities would be classed as “shadow banking”, I think this is a completely counterproductive and very dangerous idea. We need to bring shadow activities into the light, not create even larger and darker corners for them to hide in.



– European regulators are pushing big banks to raise more capital. How will this affect lending?


In the short term it will reduce it. However, once banks are better capitalised they are able to accept more risk, which should both increase the volume of lending and, more important, enhance lending to the business sector. The type of lending matters more than the amount: we really don’t need banks building up huge portfolios of property loans again while starving the business sector of investment. Capital requirements that encourage “low-risk” collateralised lending and discourage higher-risk SME lending to my mind desperately need to be changed. As Faisal Islam put it in his book The Default Line, the most dangerous financial instrument in the world is a mortgage.





About the Author

Ana Fuentes
Columnist for El País and a contributor to SER (Sociedad Española de Radiodifusión), was the first editor-in-chief of The Corner. Currently based in Madrid, she has been a correspondent in New York, Beijing and Paris for several international media outlets such as Prisa Radio, Radio Netherlands or CNN en español. Ana holds a degree in Journalism from the Complutense University in Madrid and the Sorbonne University in Paris, and a Master's in Journalism from Spanish newspaper El País.

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