Jan 24th 2020

Quantitative easing now looks permanent – and has turned central banks into pseudo governments

by Valerio Cerretano

 

Valerio Cerretano is Senior Lecturer in Management at the University of Glasgow

 

 

After a pause of a few months, the world’s leading central banks are “printing” money again to try to bolster their economies. Commonly known as quantitative easing or QE, the European Central Bank (ECB) resumed its programme just before the turn of the year. The backdrop is lukewarm growth, a looming recession in Germany, and persistent fears of Japanese-style deflation.

The ECB is creating new euros to buy bonds at a monthly pace of €20 billion (£17 billion). It is also signalling that QE has moved from being a temporary innovation to a permanent feature of monetary policy.

Meanwhile, the US Federal Reserve has also been running a new asset-buying programme, creating US$60 billion (£46 billion) a month since September. It insists for technical reasons that this is not QE, though many observers disagree. The Bank of Japan has been following a similar policy almost continually for the past decade, while there have been recent hints from the Bank of England that it might return to the fray for the first time since 2016.

At the Davos World Economic Forum, the managing director of the IMF has said that these interventions, along with many other countries cutting interest rates, amount to the “most synchronised monetary easing since the global financial crisis”.

In the process, the balance sheets of the leading central banks have ballooned to many times their previous size. As we shall see, it has given them a direct role in industrial policy that few people are even aware of.

Liquidity gets crunched

It was the economic crisis of 2007-09 that drove the European, British and American central banks to try QE. They reduced interest rates to unprecedented levels, but it did little to increase bank lending, consumption or investment. By the turn of the decade, they realised their economies were caught in a similar liquidity trap to Japan, which had been pioneering its own QE programme since the late 1990s. Nothing like this had been seen on a global scale since the 1930s.

So they began to create massive amounts of money to buy the bonds of governments, banks and other major companies. The idea was to drive up bond prices, which would at the same time drive down their yields or rate of interest. By doing this, long-term interest rates would be reduced in line with the cuts that the central banks had already made to short-term interest rates. This would make borrowing cheaper for those issuing the bonds, which would hopefully stimulate the economy.

Central bank balance sheets 2006-18

Central bank statistics

There has been much debate about whether QE has succeeded. It is often said that along with low interest rates, it has paved the way for a new speculative bubble in riskier assets, while not unlocking enough growth to have achieved a recovery. We have never returned to the growth levels of the 2000s, as shown below.

Global growth since 2000

World Bank

Commentators like former US Treasury minister Lawrence Summers argue that instead of QE, governments should be spending our way to a stronger recovery by running higher deficits. But since there is little political will for this, others believe that QE is effectively the only game in town.

The ECB, which was fiercely criticised from within the institution for resuming QE, has pointed to the benefits from the previous programme. In particular, it claims to have improved corporations’ credit access and levels of bank lending. We could add that the concerns about speculative bubbles overlook the fact that a shift in demand towards riskier assets was precisely the objective behind QE.

Some influential commentators argue that QE should be used permanently, and the ECB seems to agree. The bank’s new president, Christine Lagarde, said in December:

We intend to continue reinvesting in full the principal payments from maturing securities purchased under [the QE programme] … for as long as necessary to maintain favourable liquidity conditions and an ample degree of monetary accommodation.

The new industrialists

It is usually overlooked that QE has also led the central banks into an industrial role that is normally restricted to governments (except the Fed, which works hand in hand with the US Treasury in this regard). For instance, while over 80% of the ECB scheme buys government and other public sector bonds, a huge chunk still goes into corporate bonds and other assets. At the time of writing, the ECB holds €263 billion worth of corporate bonds – a very significant amount in relation to individual firms and the sectors in question.

According to the ECB, 29% of these bonds were issued by French firms, 25% by German firms and 11% each by Spanish and Italian firms. As at September 2017, the sectors they came from included utilities (16%), infrastructure (12%), automotive (10%) and energy (7%).

Why were those firms and sectors targeted? The selection criteria are not always clear. Unsurprisingly, the investments have raised some political criticism. Some have argued, for example, that the money should prioritise green energy firms and not the bonds of companies that trade in fossil fuels.

At any rate, these central banks are now in the business of picking winners and losers in the corporate world. They’re likely to be embroiled in this for a long time: even if they did abandon QE, they are buying assets with lifespans of over 30 years in some cases. As the Bank of Italy has admitted, the possibility of some of these companies going insolvent creates financial risks for the whole eurozone system.

It should be said that there are echoes of the past in these interventions. The likes of the Bank of England and Bank of Japan have been involved in salvaging firms or entire industrial sectors after economic downturns before. The Bank of England came to own a number of cotton mills in the 1920s, for instance, and then Rolls-Royce in the famous 1970s rescue. Another example is France in the 1950s, where the central bank became involved in choosing which sectors and companies to back under a scheme to distribute long-term finance.

The supposedly “unconventional” QE policies are therefore somewhat more conventional than is often admitted. We might like to think of central banks as technocratic institutions that merely enable the market, but not always. And the decisions about whom to prop up are being taken without any democratic input. For the situation to reverse and for the balance sheets of central banks to return to pre-crisis levels, it depends very much on whether we ever see a robust recovery. All we can say for now is that there are no signs of it yet.

Valerio Cerretano, Senior Lecturer in Management, University of Glasgow

This article is republished from The Conversation under a Creative Commons license. Read the original article.

Browse articles by author

More Current Affairs

Feb 18th 2020
EXTRACT: "Beyond the usual economic and policy risks that most financial analysts worry about, a number of potentially seismic white swans are visible on the horizon this year. Any of them could trigger severe economic, financial, political, and geopolitical disturbances unlike anything since the 2008 crisis."
Feb 18th 2020
Extract: "In late 2019, Zogby Research Services (ZRS) once again had the opportunity to poll public opinion across the Middle East and North Africa about many of these issues that are of such critical concern to the region and its peoples..............One of the more intriguing results in our 2019 survey were the changes in Arab views toward the Israeli-Palestinian conflict. Most Arabs still blame the US and Israel for the absence of peace and have little confidence that the conflict can be resolved in the near future. Maybe as a result of this despair, this issue now ranks low as an Arab priority. Also noteworthy is the fact that majorities in most Arab countries now say that normalization with Israel, which they acknowledge is already happening, may be a good thing. This development shouldn’t be overstated, however, since there is still no love for Israel. It appears, from our survey, to be born of frustration, weariness with Palestinians being victims of war, and the possibility that normalization might bring some economic benefits and could give Arabs leverage to press Israel to make concessions to the Palestinians."
Feb 15th 2020
EXTRACT: "Global dissatisfaction with democracy has increased over the past 25 years, according to our recent report. Drawing upon the HUMAN Surveys project, the report covered 154 countries, with 77 countries covered continuously for the period from 1995 to 2020. These samples were possible thanks to the combination of data from over 25 sources, 3,500 national surveys, and 4 million respondents. Not surprisingly, the gloomy headline finding – rising democratic dissatisfaction – attracted the most attention. Less widely discussed, however, is the “good news” – that a small sample of countries has bucked the trend, and have record high levels of satisfaction with their democracies."
Feb 14th 2020
EXTRACT: "This is how dictatorships begin. As the US prepares for its next presidential election in November, it is every citizen’s responsibility rationally to examine Trump’s dictatorial impulses, which reelection would only reinforce. It is not safe to assume that he won’t go too far, or that he is too much of a “mediocrity” – as Leon Trotsky called Stalin (an assessment with which many Bolsheviks agreed) – to transform his country......Vladimir Lenin, himself a ruthless Bolshevik, wrote in 1922 that, “Stalin concentrated in his hands enormous power, which he won’t be able to use responsibly,” owing to traits like rudeness, intolerance, and capriciousness. Trump has all of them in spades. The more power he concentrates in his own hands, the dimmer the long-term outlook for American democracy becomes. His reelection could mean lights out."
Feb 9th 2020
EXTRACT: "Does this mean that the dream of European unity is over? Does the exodus of a member state obliterate the vision of Victor Hugo and Václav Havel? Does Europe now fit the description of what the great American president Abraham Lincoln called a house divided against itself? Not necessarily. History is more imaginative than we are. The EU still has the option of keeping Britain close in heart and mind. We can still benefit from our absent partner, by resurrecting the partnership through our actions."
Feb 7th 2020
EXTRACT: "There, no formal change from a republican system to an autocratic system ever occurred. Rather, there was an erosion of the republican institutions, a steady creep over decades of authoritarian decision-making, and the consolidation of power within one individual – all with the name “Republic” preserved.........Will the GOP-led Senate’s endorsement of this defense clear a path for more of the manifestations – and consequences – of authoritarianism? The case of the Roman Republic’s rapid slippage into an autocratic regime masquerading as a republic shows how easily that transformation can occur."
Feb 7th 2020
EXTRACT: "So all that is why Cramer is talking about the death knell of petroleum stocks. We probably agree on almost nothing else, but when people are right, you have to give them credit. He is right."
Feb 3rd 2020
EXTRACT: "........as the citizens of the remaining 27 states have observed the destabilising impact that the referendum decision has had on British politics, they have been inoculated against the desire to secede from the EU. Outside the UK, national-populist parties have moderated their anti-EU rhetoric and nowadays profess to want to change the EU from within instead of destroying it."
Feb 2nd 2020
EXTRACT: "Senators will soon decide whether to dismiss the articles of impeachment against President Donald Trump without hearing any witnesses. In making this decision, I believe they should consider words spoken at the Constitutional Convention, when the Founders decided that an impeachment process was needed to provide a “regular examination,” to quote Benjamin Franklin. A critical debate took place on July 20, 1787, which resulted in adding the impeachment clause to the U.S. Constitution. Franklin, the oldest and probably wisest delegate at the Constitutional Convention, said that when the president falls under suspicion, a “regular and peaceable inquiry” is needed."
Feb 1st 2020
EXTRACT: "Britain will be celebrating its glorious independence from the complications of international cooperation at a time when the intellectual, political, and economic hostility between China’s communist leadership and liberal democracies is becoming ever clearer. If liberal democracy is to survive, it must stand up for itself. And we should be under no illusion: open societies under the rule of law, from the Americas to Europe, Africa, and Asia, are in China’s hostile sights. The West should not aim to encircle or pen in China. But liberal democracies cannot allow it to distort international norms in its own favor."
Jan 29th 2020
EXTRACT: "Switzerland and Denmark have gone furthest into negative territory, both offering unprecedentedly low rates of -0.75%. The Swiss National Bank, which has kept its rate at this level since 2015, signalled recently that it intends to stick with this experiment and is not ruling out going even more negative. It has said that negative rates were boosting the economy and that the country’s fundamentals were not being significantly affected."
Jan 28th 2020
EXTRACT: "Electricity will dominate the future global energy system. Currently, it accounts for only 20% of final energy demand,......Without assuming any fundamental technological breakthroughs, we could certainly build by 2050 a global economy in which electricity met 65-70% of final energy demand,....."
Jan 27th 2020
EXTRACT: "With the world economy operating dangerously close to stall speed, the confluence of ever-present shocks and a sharply diminished trade cushion raises serious questions about financial markets’ increasingly optimistic view of global economic prospects."
Jan 26th 2020
EXTRACT: "Gibson’s diagnosis is supported by international attitude surveys. One found that most Americans rarely think about the future and only a few think about the distant future. When they are forced to think about it, they don’t like what they see. Another poll by the Pew Research Centre found that 44% of Americans were pessimistic about what lies ahead. But pessimism about the future isn’t just limited to the US. One international poll of over 400,000 people from 26 countries found that people in developed countries tended to think that the lives of today’s children will be worse than their own. And a 2015 international survey by YouGov found that people in developed countries were particularly pessimistic. For instance, only 4% of people in Britain thought things were improving. This contrasted with 41% of Chinese people who thought things were getting better."
Jan 24th 2020
EXTRACT: "........while over 80% of the ECB scheme buys government and other public sector bonds, a huge chunk still goes into corporate bonds and other assets. At the time of writing, the ECB holds €263 billion worth of corporate bonds – a very significant amount in relation to individual firms and the sectors in question. According to the ECB, 29% of these bonds were issued by French firms, 25% by German firms and 11% each by Spanish and Italian firms. As at September 2017, the sectors they came from included utilities (16%), infrastructure (12%), automotive (10%) and energy (7%)."
Jan 17th 2020
EXTRACT: "Thanks to cutting-edge digital technology, cars are increasingly like “smartphones on wheels”, so manufacturers need to have access to the latest patented 4G and 5G technologies essential to navigation and communications. But often the companies that hold the patents are reluctant to license them because manufacturers will not accept the high fees involved, which leads to patent disputes and licensing rows."
Jan 13th 2020
EXTRACT: "Recent polling from Pew Research demonstrates how the public’s attitudes toward the US and President Trump have witnessed sharp declines in many nations across the world. In Europe, the Americas, and the Middle East favorable attitudes toward the US went from lows during the years of George W. Bush’s presidency to highs in the early Obama years to lows, once again, in the Trump era. And in our Zogby Research Services (ZRS) polling we found, with a few exceptions, much the same trajectory across the Middle East."
Jan 13th 2020
EXTRACT: "In the absence of a declaration of war against Iran, the killing of a foreign official – by a drone strike on Iraqi territory – was possibly illegal. But such niceties do not perturb Trump. The evidence is that Trump’s decision was taken without consideration of the possible consequences. The national security system established under Dwight D. Eisenhower, designed to prevent such reckless measures, is broken to non-existent, with ever-greater power placed in the hands of the president. If that president is unstable, the entire world has a very serious problem."
Jan 9th 2020
EXTRACT: "It is possible that Trump’s reverential base won’t be sufficient to keep him in the White House past 2020. But such ardent faith is hard to oppose with rational plans to fix this or that problem. That is why it is so unsettling to hear people at the top of the US government speak about politics in terms that rightly belong in church. They are challenging the founding principles of the American Republic, and they might actually win as a result."