The Economist kindly invited me to contribute an op-ed to a ’roundtable’ on what form Quantitative Easing should take place in Europe. For The Economist’s site click here. Or read on…
A QE proposal for Europe’s crisis
MARIO DRAGHI understands that to stave off deflation, the ECB must not only reverse the steady diminution of its balance sheet, but boost it by something in the order of €1 trillion over the next few years. On the other hand, Mr Draghi is politically constrained regarding the class, and volume, of assets he can purchase without testing the limits of his influence over Berlin.
In the absence of eurobonds, the ECB is bound to step into a political quagmire if it were to purchase government bonds. The current pre-occupation with engendering a new ABS market so as to buy its, currently, non-existent wares smacks of desperation.
While the ECB’s board is seeking ways to overcome this operational problem, opponents of QE throw another spanner in the works. They argue, not without justification, that the experience of Britain and America has demonstrated that QE is ineffective in fostering real investment but effective at inflating asset bubbles.
Thus, caught between its operational problem and macroprudential concerns, the ECB seems confined to the role of a spectator of unimpeded deflationary forces. It is easy to resign ourselves to this paralysis. But it is wrong and unnecessary. Here is something that the ECB could do that overcomes its twin problems (the operational constraint and macroprudential concerns regarding QE) while spearing investment-led recovery without new government debts and without violating any treaties (including the ECB’s own charter).
The proposal is for QE to focus exclusively on European Investment Bank (EIB) bonds.* The idea is simple:
- Europe desperately needs large-scale, growth-inducing investment.
- Europe is replete with idle cash which people are scared to invest into productive activities, fearing lack of aggregate demand once the goods roll off the production line.
- The ECB wants to buy high-quality paper assets in order to stem the deflationary expectations that are the result of the above.
- The ECB does not want to have to buy German, Italian or Spanish assets lest it be accused of favouring one of those countries.
So what should Europe do?
- The European Investment Bank (and its smaller offshoot, the European Investment Fund) should embark upon a pan-euro-zone investment-led recovery programme worth 8% of euro-zone GDP. The EIB would concentrate on large-scale infrastructural projects and the EIF on start-ups, SMEs, technologically innovative firms, green-energy research etc.
- The EIB/EIF has been issuing bonds for decades to fund investments, covering 50% of the projects’ funding costs. They should now issue bonds to cover the funding of the pan-euro-zone investment-led recovery programme in its totality; that is, by waving the convention that 50% of the funds come from national sources.
- To ensure that the EIB/EIF bonds do not suffer rising yields, as a result of these large issues, the ECB can to step in the secondary market and purchase as many of these EIB/EIF bonds as are necessary to keep the EIB/EIF bond yields at their present, low levels. To stay consistent with its current assessment, the level of this type of QE could be set to €1 trillion over the next few years.
In this scenario, the ECB enacts QE by purchasing solid eurobonds. The bonds issued by the EIB/EIF are issued on behalf of all EU states. In this manner, the operational concern about which nation’s bonds to buy is alleviated. Moreover, this form of QE backs productive investments directly, as opposed to inflating risky financial instruments, and has no implications in terms of European fiscal rules (as EIB funding need not count against member states’ deficits or debt).
By purchasing large quantities of EIB bonds, the ECB can, in partnership with the EIB, help shift idle savings (that currently depress yields on all investments) into productive activities. This would be tantamount to a European New Deal.
One might counter that the EIB may simply be unable or unwilling to conjure up ‘shovel-ready’ projects to the tune of €300 billion annually, both because it is worried about its creditworthiness and due to a lack of potentially profitable projects. My retort is twofold.
- The ECB’s QE support of EIB bonds will guarantee that the EIB yields will remain ultra-low for a long while, alleviating any pressure from credit-rating agencies.
- Europe desperately needs investment in energy (where its competitiveness is currently declining at a worrying pace), transport, and basic infrastructure (even Hamburg’s port is crumbling). In the short run, the EIB-ECB partnership can take over projects that fiscally stricken governments have mothballed. Gradually, new projects promising to deal with Europe’s burgeoning energy crisis will come on stream with great potential for profitable investment, ‘crowding in’ private investment in the process.