Different housing markets, politics, multiple bond markets all complicate ECB stimulus effort

FRANKFURT – Big bang or disappointment? Markets are waiting to see just how much financial firepower the European Central Bank will unleash Thursday, when it is expected to announce large-scale purchases of government bonds with newly printed money to stimulate a sluggish economy.

The decision to use bond purchases, or so-called quantitative easing, follows in the footsteps of the U.S. Federal Reserve — as well as the Bank of England and the Bank of Japan. The Fed bought bonds from 2008 to 2014 — and got credit for helping jump-start an increasingly robust U.S. recovery.

Europe could definitely use a push. Growth is weak, unemployment is 11.5 per cent and inflation is minus 0.2 per cent annually, which has raised fears the region could face chronic deflation. Bond purchases would fight that by pumping new money into the economy, raising inflation and making credit cheaper and easier to get. The euro would fall, boosting exports.

Yet the Fed and the ECB inhabit different economic landscapes. The ECB’s job is complicated by a host of factors. Here’s a look at the differences:


The Federal Reserve could buy bonds in well-established, reasonably safe markets for Treasurys and mortgage-backed securities. The ECB has 19 governments and bond markets to choose from — ranging from super-safe Germany to shaky Greece. It needs to decide whose bonds to buy and whether or not to include risky ones too.

“They have a problem: Should they buy Italian debt or Spanish debt or Greek debt?” said Edwin Truman, senior nonresident fellow at the Peterson Institute for International Economics in Washington D.C. and a former Fed official. “There’s not much to be gained by buying German debt — but they can’t really not buy German debt” for political reasons. It’s as if the Fed had to buy bonds proportionally from all 50 U.S. states, he says.



Draghi has a political battle on his hands with Germany, which has clout because of its dominant role in the European Union. Two German members of his 25-member governing council have expressed public skepticism about bond purchases and are expected to oppose it Thursday. They worry such a move would mean German taxpayers would be handed the bill in case of bond default from less prudent Italians and Greeks. German Chancellor Angela Merkel has neither endorsed QE nor condemned it.

Draghi appears to have the skeptics outvoted, but lack of clear consensus could undermine the market’s perception of the ECB’s resolve to stick with it until inflation reaches its goal.

In the U.S., Fed Chairman Ben Bernanke and successor Janet Yellen faced sharp criticism from Republican politicians. But inside the Fed, they received support from a majority of members of the central bank’s policymaking committee and as the unemployment rate fell to 5.8 per cent in October 2014 from 10 per cent in October 2009, the naysayers were easily outvoted.



The ECB would be commencing purchases after bond market interest rates have already fallen substantially since the height of the eurozone crisis in mid-2012. That means purchases to drive yields down further will have less effect than they would have had three years ago.



The political criticism leads some analysts to worry Draghi may be forced to compromise on the size of the program, leaving it too small to impress markets. Analyst Frederik Ducrozet at Credit Agricole says markets are already expecting at least 500 billion euros ($580 billion) and anything less would disappoint. A program of at least 500 billion euros per year, with flexibility to do more, would be a positive surprise.

The best hope, Ducrozet said, is a compromise with the skeptics, where Draghi gets a bigger program in return for not sharing default risk among countries.

By contrast, the Fed’s program added $3.6 trillion in assets to the bank’s balance sheet, in three rounds of purchases. And when the Fed plunged in with its third round, it simply promised $85 billion in purchases a month for as long as it took — no limit.



The European and U.S. economies are set up differently, particularly when it comes to credit. European companies get most of theirs from banks, not from the bond markets as do U.S. firms. That means driving down bond market interest rates doesn’t help as directly. Banks will get the QE money by selling their bonds — but whether it gets into the economy depends on whether businesses see enough growth ahead to risk borrowing.



The Fed’s QE boosted the economy by raising the prices of homes through cheaper mortgage rates. That let Americans tap home equity loans they could spend. They could refinance and reduce monthly payments and they felt wealthier and more willing to consume.

Yet rising house prices have the opposite effect in France and Germany, says John Muellbauer, senior research fellow in economics at Oxford University’s Nuffield College. Home owners there generally can’t get affordable home equity loans due to more conservative banking practices. In Europe, “your home is not an ATM machine,” he said. “So when the value of your home goes up, it’s very hard to translate that into more borrowing and to go out and spend it.”

In fact, says Muellbauer, an increase in home prices in Europe tends have the opposite effect than in the States: it leads to less spending, as people who want to buy a home scrimp more, and renters begin to expect increases and hold back on spending.


Paul Wiseman contributed from Washington.