The ECB, QE and escaping stagnation

by Michael Roberts

The announcement by Mario Draghi at the council meeting of European Central Bank (ECB) yesterday that the ECB and the national central banks of the Eurozone would inject €1.1trn of new credit over the next 18 months into the area’s banks has certainly had a quick result. The euro dropped to an eleven-year low against the US dollar.

The ECB has finally joined the Federal Reserve, the Bank of England and the Bank of Japan is what is called outright quantitative easing (QE). This is the outright purchase by the central banks of government, corporate and real estate bonds paid for by ‘printing money’, or more precisely electronically creating reserves of money in banks.

Up to now, the ECB has shied away from doing this QE and instead merely lent money or credit to the banks for increasingly longer periods of time (now up to three years) at virtually zero rates of interest. The German and northern European governments were opposed to the outright purchase of the bonds of Ireland, Spain, Portugal, Italy and Greece, the profligate governments. They feared that such purchases would allow these governments to spend as they pleased and put at risk the German taxpayer from any defaults on this debt.

But such has been the stagnation of most Eurozone economies and the growing prospect of outright deflation that the Germans, Dutch and Finns have been ‘persuaded’, kicking and screaming, that the ECB must go for broke and buy Italian and Spanish bonds held by banks, insurance companies, pension and hedge funds and hope that it helps kick-start the Eurozone economy and avoid deflation.
As I explained in a previous post
(https://thenextrecession.wordpress.com/2015/01/11/the-spectre-of-deflation/)
and also now in an article for the Weekly Worker this week
(http://weeklyworker.co.uk/worker/1042/the-spectre-of-deflation/),
there is the spectre of deflation hanging over Europe, which could drag the whole region into a deep depression and a renewed euro crisis. So action was needed.

The Draghi package is much bigger than expected, injecting funds equivalent to 0.6% of Eurozone GDP every month. This is bigger in relative terms than any other QE programme from the Fed, the BoE or the BoJ.


There was a figleaf to the German doubting Thomases in that 80% of the supposed risk from new purchases of government debt would be down to national central banks and not shared across the Eurosystem. But that’s an illusion: if any national central bank got into trouble with losses from the purchase of its own government’s bonds, the ECB would have to bail them out anyway.
So the real question is: whether this huge QE will lift the Eurozone economy from its near deflationary depression. Well, it certainly is driving the euro down. That will help Eurozone exporters to compete in world markets against the likes of the Swiss, US and some Asian producers. But as most exports of each EMU member state are to each other, a weaker euro will not be enough to get things going.

Unless real wages (which have been falling in most Eurozone economies) and business investment (which remains stagnant in most Eurozone economies) start to pick up, there will be no escape from stagnation and depression. And QE will not do that, as I explained in more detail in a previous post (https://thenextrecession.wordpress.com/2014/11/02/the-story-of-qe-and-the-recovery/). Since the use of QE from 2010 by various central banks, global growth has remained weak and below trend and the recovery in employment and investment has been poor despite a huge electronic printing of money.  Real economic growth has not responded.

It’s demand for credit or money that drives the supply of money, not supply creating demand. And the demand for money has been weak because economic activity is weak. To use another cliché: you can bring a horse to water, but you cannot make it drink.  The ‘money multiplier’, the ratio of the amount of money printed by the Fed relative to the amount of money flowing into the wider economy has dropped like a stone.

QE has not worked in raising rates of economic growth back to pre-crisis levels. So where has all the money gone? It has gone into the banking system to shore up their balance sheets and restore their profits. And it has engendered a massive bubble in financial assets; and the prices of government and corporate bonds and most of all, stock prices, have rallied to record highs.

The only beneficiaries have been the top 1% of wealth holders everywhere as they own the bulk of financial assets.

When QE was begun back in 2010, mainstream economists, both monetarists like former Fed chair Ben Bernanke and Keynesians like Paul Krugman, saw QE as the main economic weapon to get economies moving. Krugman even argued that the Bank of Japan’s QE programme would get Japan out of its stagnation.

How wrong can you be? The BoJ’s target of a 2% inflation rate remains a chimera some four years later, while Japan’s real economy hovers near recession, despite a QE programme that has meant a rise in the BoJ’s holdings of government bonds equivalent to 50% of GDP and rising (https://thenextrecession.wordpress.com/2014/10/13/japan-the-failure-of-abenomics/). It will be the same result for the ECB’s QE programme: the euro may fall, as did the yen after the BoJ started its programme. But there will be no significant recovery in economic growth.

The Keynesians go insisting for even more QE. But they also look to more fiscal action, namely running higher budget deficits for longer so that governments start to spend more on infrastructure, government services and benefits and even defence. This might provide some limited support for growth. But extra government borrowing is anathema to the strategists of capital because it would eventually mean higher interest rates and possibly higher taxation down the road, and thus lower profitability at a time when profitability in most economies is still below the level before the Great Recession (see my post, https://thenextrecession.wordpress.com/2012/06/13/keynes-the-profits-equation-and-the-marxist-multiplier/ and the joint paper by G Carchedi and me on the effectiveness of Keynesian-type fiscal spending, The long roots of the present crisis).

Indeed, far from looking to increase QE or government spending, the US Fed is getting ready to hike its ‘policy rate’ later this year. And the risk is that if the Fed does implement a hike in interest rates in 2015, then the financial boom will also collapse and profits will begin to fall, increasing the risk of a new slump (see my post, https://thenextrecession.wordpress.com/2014/08/01/the-risk-of-another-1937/).

Mainstream economists have started to recognise that the major capitalist economies are not ‘returning to normal, but are locked into something they now like to call ‘secular stagnation’, the main theme of the recent annual meeting of the American Economics Association (see my post). How can economies escape?

A new report from the OECD attempts to provide some answers (escaping-the-stagnation-trap-policy-options-for-the-euro-area-and-japan-1). The OECD is starkly clear: “The global economy continues to run at low speed and many countries, particularly in Europe, seem unable to overcome the legacies of the crisis. With high unemployment, high inequality and low trust still weighing heavily, it is imperative to swiftly implement reforms that boost demand and employment and raise potential growth. The time to act is now. There is a growing risk of persistent stagnation, in which weak demand and weak potential output growth reinforce each other in a vicious circle.”
Even more darkly, it goes onto to say: “The cylinders of the world economy continue to fire at only half speed. Growth is low and uneven and some parts of the world, such as the euro area, are at risk of falling into a trap of persistent stagnation, an extended period of low overall economic activity and low employment despite extraordinary monetary stimulus. A vicious circle is developing, with weak demand undermining potential growth (e.g. via a deterioration of the capital stock, structural unemployment and higher inequality) and weak potential growth further reducing demand (e.g. by discouraging capacity-expanding investment).”

It really could not be worse, short of another global slump. So what is to be done?
The OECD backs the current policy of QE and talk of investment spending. “With Japan’s launch of the “three arrows” in 2013, the EU’s recent launch of an investment plan and the euro area’s expected move towards quantitative easing, the likelihood of escaping the stagnation trap is increasing.” But it won’t be enough: “further action is needed to sustain this positive reform momentum.”

And what could this be? “structural reforms are urgently needed to remove regulatory bottlenecks to investment, reduce the administrative burden for business, and facilitate company restructuring.” In effect, the OECD wants even more deregulation in business practices, complete ‘flexibility’ in labour markets and more free trade, particularly in services: “reducing regulatory barriers …Further dismantling border and behind-the-border barriers to the international movement of goods and services will serve both to expand demand and make markets more competitive and dynamic”. In other words, the OECD wants more ‘neoliberal’ policies to allow ‘market forces’ to work. In effect, it wants ‘free markets’ in labour to keep wage costs down and free movement of capital internationally to raise profitability. Apparently, the problem is that capitalism is not being allowed to work, not that it does not work.

QE has failed in the last four years to get the major capitalist economies going; fiscal deficit spending has not worked in Japan either; so the strategists of capital look to the ‘third arrow’ of weakening labour and extending the ‘free’ movement of capital as the answer. But another slump that destroys capital values and raises average profitability is more likely to be the way out for capital.