Quantitative Easing in the Eurozone

Includes: EWG, EWP, EWQ, FXE, IEV, IRL
by: Firat Ünlü

Given that the American Fed, British BoE and Japanese BoJ have all been engaging in various sorts of quantitative easing (QE), the reluctance of the ECB to conduct such operations itself has been one of its distinguishing policy features.

The ECB remains one of the most independent central banks in the world however budget constraints are appearing all over Europe and even traditional deficit hawkish members such as Germany face a worrying pile of debt which will has to be issued in the forthcoming years. Unless the macro-situation improves and organic economic growth (i.e. growth absent of government stimulus spending) appears, the gap between revenue and expenditure is going to remain unsustainably high in the whole Eurozone. What has been neglected so far in the discussion about QE in the EZ is that Germany may very well alter its position. Borrowing at the federal level in 2010 will likely surpass 100 billion euro.

A drastic increase in unemployment was only averted by introducing short-term measures such as 'Kurzarbeit'. These measures, along with business confidence in renewed organic growth, fade out in 2010. An important election will be held in May 2010 in the influential state of North Rhine-Westphalia.

As on the federal level, the coalition consists of CDU and FDP. It is probably not solely a quirk of German politics that any information on spending cuts or tax increases will only make its way into the public until after the election. For now, no credible plan to cut the deficit is in sight. The party which introduced wide-ranging social reforms, the SPD under Schroeder, faces years in the wilderness of opposition as it alienated huge parts of its clientele by pushing through exactly those reforms. The success of the Left Party is mostly down to this.

Angela Merkel is fully aware of the trouble that comes with reform and reigning in social spending and has so far proven to be a Chancellor who, despite enjoying wide-ranging popularity, hasn't really produced anything that would signal ability or readiness to push through the tough measures which will have to come soon.

What makes the situation complicated is that in 2016 a new law kicks in which does not permit budget deficits in excess of 0,35%. Spending would have to be cut by about 10 billion each year to comply with this law. However, her coalition partner, FDP, promised tax cuts during the election. This situation has led some commentators to speculate that 'taxes will have to be raised in order to cut taxes'.

With the German budget itself failing to meet the Maastricht Criteria for the forseeable future and the other big three economies in the same boat, it appears that governments will put pressure on the ECB to lighten its stance on monetary policy.

A fear of high inflation, if not hyperinflation, may still be prevalent in Germany and other nations; however with QE in the UK, Japan and US failing to push inflation significantly above 2%, it is likely that those fears will give way to 'realpolitik' as proponents of QE will point out to the assumed benefits.

Greece, Ireland and Spain will not be bailed out. They can't be bailed out. Faced with trouble at home and pressured by a host of nations, Germany may decide to alter its view and put its worries about a joint euro bond to the side. There's no point in playing the fiscal hawk and lecturing states that fail the Maastricht Criteria by a factor of three or four when Germany itself fails them by a factor of two.

Disclosure: No positions