From my perspective, QE has always seemed to me to be likely to be:
- Very effective if it changes expectations of the future price level–that shakes rates rates of return significantly, and gives real people powerful incentives to spend their cash now.
- But setting up QE in such a way that it changes expectations of the future price level is difficult: the problem is that QE transactions are easily undone in the future, and there is every reason to think that an inflation-targeting central bank will undo them in the future.
- And if QE does not change expectations of the future price level its effects on real rates of return are minimal.
Think of it: for the ECB to buy €1 trillion of ten-year EU government bonds which have a term premium of 0.1%-point per year of duration means that the ECB takes duration risk off of private-sector balance sheets that the private market currently charges €10 billion/year to bear. It frees-up that risk-bearing capacity to be deployed elsewhere. In a €20 trillion/year Eurozone economy that is 0.05%. You can blather about financial accelerators and credit multipliers all you want, but it is a very uphill task to convince me that that is a big deal.
So why do it?
- It is a small plus.
- It might become part of a process that moves expectations and turns into a big plus.
- There is nothing else politically practical on the agenda that might be done that QE takes attention away from.
The very sharp Paul de Grauwe:
…First, QE is merely a correction for… the last two years… [when] the ECB withdrew about €1 trillion out of the euro-zone economy…. Second, the euro-zone economy is not getting off the ground…. Since Milton Friedman we have all become monetarists. In order to raise inflation it will be necessary to increase the growth rate of the money stock. This requires that the ECB increase the money base. And to achieve the latter there is only one practical instrument, ie, an open-market purchase of government bonds…. But… QE… is necessary but not sufficient. The fact that it is not sufficient, however, should not lead to the conclusion that it can be dispensed with….
There is much misunderstanding and fear regarding QE, especially in Germany. There is the fear that… German taxpayers risk having to foot the bill…. [But] if… say the Italian government were to default… [it] would stop paying interest but at the same time (applying the ‘juste retour’) it would not get any interest refund… no fiscal transfers…. [Any] write down ]of] the Italian bonds… [would be] purely an accounting operation…. A central bank… does not need equity…. This confusion between accounting losses and real losses… has led to long hesitation to act… leads to bad ideas and wrong proposals…