Europe’s deflation risk leaves no option but quantitative easing / FINANCIAL TIMES.

FT View

Europe’s deflation risk leaves no option but quantitative easing

The ECB must now go full speed ahead to prevent the slide in prices

January 9, 2015 / http://www.ft.com/intl/cms/s/0/76e4a266-97ff-11e4-b4be-00144feabdc0.html#axzz3P9QylNOj

Inflation data for the eurozone confirmed this week what we already know. Even abstracting from the effects of oil, the core rate of price rises remains perilously close to zero — and inflation expectations remain frighteningly low. In this context, it is more urgent than ever that the European Central Bank pushes ahead with the strongest form of quantitative easing it can muster.

That will not be easy. As well as continued scepticism from the Bundesbank and the German government, the ECB is facing the prospect of a ruling next week from the European Court of Justice that may restrict its ability to purchase sovereign debt outright. Mario Draghi, the ECB’s president, is having a tricky enough time with the economics and politics of QE without having to tiptoe round the constitutional law. Nonetheless, he should aim to use whatever freedom of manoeuvre he has to expand outright purchases of government bonds.

True, QE is by no means guaranteed to produce growth and stable positive inflation. There are good reasons to think that an operation in the eurozone will have more difficulty getting traction than in the US or the UK. QE is already priced into the market, suggesting that any plan will have to be spectacular to jolt expectations of inflation and growth upwards.

Moreover, buying eurozone government bonds with their low yields may have a limited effect on private willingness to borrow and spend. If the ECB is forced to delegate the bond purchases to the individual national central banks, fears about their future solvency could increase rather than decrease risks in the periphery.

What the ECB should be doing is financing a fiscal expansion, not pushing valiantly on what may turn out to be a monetary policy string. Those rock-bottom bond yields (with the exception of Greece) are practically begging governments to borrow and spend. The position of the German economic establishment is indefensible: it refuses to undertake a fiscal expansion itself while trying to hamstring a less effective central banking substitute.

The eurozone has been faced with two big challenges over the past five years and, thanks to the poor design of the currency union, it has responded with the wrong tool each time.

The response to the sovereign debt crisis in the periphery between 2010 and 2012 should have included the central bank clearly standing behind government borrowing across the eurozone. Instead, governments, the EU and the International Monetary Fund painfully pieced together a clumsy crisis lending operation which responded slowly and weakly. Only when Mr Draghi took over as ECB president in 2011 and issued his famous plea to do “whatever it takes” the following year did the risk of eurozone-wide contagion recede.

With the threat having now shifted to deflation, the position has been reversed, and the ECB is forced to try to make up for the shortcomings of its fiscal counterparts. Given his limited options, Mr Draghi is right to push ahead with QE. The balance of risks strongly argues for trying tool after tool until finding one that works. But it should not necessarily be regarded as the ECB’s fault if it fails to jump-start the economy.

The eurozone cannot go on as it is. Growth is weak to non-existent; there is a chronic deficiency of demand which is turning acute; the risk of pervasive and persistent deflation only continues to grow. The ECB is one of the few institutions in Europe that seems willing to try to arrest the slide. It should go full speed ahead.