European Central Bank (ECB) President Mario Draghi’s version of quantitative easing (QE) might turn out to be rather different from the type deployed by the US Federal Reserve.
As ECB officials try to stamp out the risk of deflation, Draghi on Thursday gave his strongest signal so far that the ECB is prepared to embrace a policy that has become a byword for large-scale government bond purchases. However, the structure of the euro region’s economy means the ECB will also need to find its own approach to QE.
Draghi is using the QE label as a tool to convince investors that policy makers in the 18-nation euro region are determined to prevent a Japan-style deflationary spiral. At the same time, there are political and economic obstacles to a euro-wide wave of sovereign-bond purchases, and a program aimed at boosting bank lending may prove to be more effective.
“The ECB is likely to be more focused on buying bank loans than on buying government bonds,” said Elga Bartsch, chief European economist at Morgan Stanley in London. “Given the political and legal concerns around purchases of government bonds, we continue to believe that a consensus on buying private-sector assets would be easier to reach.”
Draghi on Thursday said the ECB Governing Council was “unanimous” in its commitment to exploring new policy avenues, including asset purchases.
“There was a discussion about QE; it wasn’t neglected,” he said in Frankfurt, after policymakers decided to keep their benchmark interest rate at a record-low of 0.25 percent.
Draghi is trying to steer an economy that has lending dynamics different from those of the US, where deeper capital markets make it easier for the Federal Reserve to guide the economy through asset purchases.
While US firms tap markets for about three-quarters of their lending, companies in the euro region rely on loans from banks for the same proportion of their borrowing.
That makes it harder for the ECB to use asset purchases as a way to improve credit conditions for small-and-medium sized enterprises, the backbone of Europe’s economy.
“The banking system is more essential to the euro area than other financial systems that are more market-based,” Draghi said. Any program “has to be carefully designed in order to take this element into account,” he said.
Buying sovereign bonds is politically and legally difficult for Draghi. The ECB’s founding treaty forbids it from financing governments. Draghi would also have to choose which countries’ bonds the central bank should acquire.
If the ECB were to purchase debt proportionate to the size of its member countries, more than half would come from nations like Germany and France. Targeting peripheral countries could undermine efforts to make them rein in spending.
Draghi’s remarks nevertheless suggest that ECB officials are committed to new measures, whatever the challenges.