Weak recovery in Europe leads to mention of asset purchases by ECB leaders; but would it work?

David McHugh, The Associated Press 0

FRANKFURT – Alarmingly low inflation and weak growth have led officials at the European Central Bank to consider what had once seemed unthinkable: A Federal Reserve-like program of large-scale bond purchases to jolt the region’s economy.

Even though the topic appears to be up for discussion, analysts say that the ECB may never take such a drastic step for both political and practical reasons. That’s even though others, including the U.S. Federal Reserve, have used such purchases to try to stimulate their economies.

But the mere fact that several top ECB officials are talking about asset purchases represents a bit of a shift. Executive board member Peter Praet mentioned the possibility of purchasing assets during an interview last week with the Wall Street Journal. And Vice-President Vitor Constancio did the same on Tuesday.

Such purchases, dubbed quantitative easing or QE, by economists, involve using newly created money to buy financial assets such as bonds from private-sector institutions. That can drive down longer-term interest rates, increase the supply of money in the economy and boost growth. It can also lower a country’s exchange rate, bringing trade advantages.

For years, ECB officials said very little about QE even though other central banks took the plunge. The idea is met with skepticism in Germany, in particular, where many regard it as potentially inflationary and unduly rewards those indebted governments who have failed to take the necessary steps to shore up their economies.

The catalyst for the current discussion about QE was the fall in the eurozone’s inflation rate to 0.7 per cent in the year to October, way below the ECB’s goal of just under 2 per cent.

That raised a new worry for a region that’s grappled with a debt crisis and a weak economy for years: does Europe face outright deflation — a corrosive, chronic fall in prices that has afflicted Japan for years? Or is the drop caused by benign factors such as lower fuel prices, and efforts of indebted countries such as Greece, Portugal and Spain to lower their relative prices to make their economies competitive again?

ING analyst Carsten Brzeski said the ECB’s primary mandate — pursuing stable prices — means that German objections become weaker if deflation is a real threat. He added that serious obstacles remain such as strained bank finances in southern Europe.

ECB president Mario Draghi has said little publicly about potential asset purchases aside from a comment that “there are a whole range of instruments that we can activate, if needed.”

Here are other steps the bank could take to get more money in circulation:

— Cut the amounts of cash banks are required to keep on reserve at the ECB

— Lower the rate for bank deposits at the ECB to below zero, which could get them to loan money rather than hoard it

— Make another round of cheap, long-term loans to banks, following two earlier ones that handed out more than 1 trillion euros ($1.34 trillion).

— Draghi has said the ECB could cut the current interest benchmark lower. There’s little room left to do that, however after it was reduced to a record low of 0.25 per cent earlier this month.

Germany’s top central banker, Jens Weidmann, said the ECB doesn’t’ need to hurry on a further stimulus. “I don’t think it’s a good idea to announce the next round right away,” he said in an interview with Die Zeit newspaper made available Wednesday.

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