Mario Draghi, the head of the European Central Bank (ECB) announced earlier this week that the ECB will scale down and cease its purchases of assets, a policy known an Quantitative Easing, or QE, and it expects interest rates to remain at zero at least through the summer of 2019 reports the Economist. QE is a policy which was adopted by many central banks after the Great Recession of 2008 but it was first used in Japan in 2001 to fight deflation. The aim of QE is to give banks a lot of cheap money to stimulate the economy and raise inflation to the central bank's target, as Milton Friedman put it "inflation is always and everywhere a monetary phenomenon". There are several problems with a policy of QE and in this piece I will raise two, one economic and one political.
First off, as with most things in life there are diminishing returns to lowering interest rates to stimulate the economy. When the central bank lowers interest rates they can get trapped in what's known as the 'liquidity trap' where lowering interest rates won't have any significant impact on the economy as the interest rates were quite low to begin with. Say for example that there is a downturn in the economy and the central bank wants to stimulate investment to reduce the harm to the economy. Then if the central bank is stuck in the liquidity trap monetary policy can't be used for this purpose, worse though is that raising interest rates can have a negative impact on the economy. To me, QE looks an awful lot like a liquidity trap. After all, interest rates are in many places already zero and in some places even negative. The global economy is doing quite well at the moment, Geopolitical Futures reported earlier this year that the all the major economies are growing for the first time since 2008. While that is good news history shows that what goes up must come down and, as I'm sure you are aware, the next recession is a matter of when not if. Governments will struggle to contain the next recession if one of their tools in the form of monetary policy can't be used.
The next problem is that the gains from QE are mainly going to the wealthier classes in society. Why is that? Shouldn't everyone benefit from cheap money? Firms can invest cheaply and private citizens can buy homes for cheap which should benefit everyone? Well, debt is cheap for firms meaning that investing and servicing debt is cheap but firms only invest if they believe they have something to gain from it. American firms have earned unusually high profits since the end of the Great Recession simply because they have not invested as much one would expect. The reasons firms haven't invested too much is because they have been worried about the future, and rightly so. Since the American economy recovered there was the Eurozone crisis and many worrying international events such as the Russian annexation of Crimea. This means that firms have profited greatly which mainly benefits those entitled to a part of firms profits, i.e. those who own shares. Those who own shares tend to be better off economically and they also tend to own their homes which have also greatly appreciated in value as the price of the credit most need to buy a home has become cheap, leading to large increases in housing prices in major cities across the world. So those 'elites' who are seen as being responsible for wrecking the world economy and causing the Great Recession has also greatly profited off one of the major policies meant to help the economy recover. It's not hard to see why the message of "draining the swamp" and "taking back control" appeal to those who have suffered from the Great Recession.
Draghi has now announced the end of QE and I think it's probably a good thing. Let's just hope that the end of QE doesn't trigger the next recession, who knows what the consequences of that would be.
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