Domestic demand inflation and QE
Eurozone inflation continues to be low, even in Germany where unemployment is less high (Graph 1, Eurostat, inflation defined as Domestic Demand Inflation, which does not just cover consumer prices but also investment and health care and education price and export prices). A country like Greece even experiences grinding deflation. Which seems nice: everything is getting cheaper. But which also means that it is getting ever harder to pay down your debts, as incomes and profits decline (Greece was the EZ country with the highest deflation in the Eurozone, Germany the country with the highest inflation).
Does this low inflation mean that QE (Quantitative Easing, i.e. a central bank which buys bonds) does not work? At this moment a lot of people tend to look at a graph like graph 1 and answer ‘It doesn’t!’. But are they right? I think they are, but for the wrong reason. Graph 2 shows the growth rate of Euro creating lending. As can be seen, borrowing (from banks) increased pretty fast before 2008.
This high level of borrowing of course led to legacy debts, which people and companies try to pay down (see the decline of borrowing between 2011 and 2013). Siphoning off money from your stream of income to pay down debts however leads to depressed spending and acts as a drag on growth. QE tries to counteract that by decreasing the short and long-term interest rates (and, in the Eurozone, by equalizing the rate of interest between countries and banks), which has to stimulate new investment and lending. But do we really want more debt to solve the problem of these legacy debts by tempting people to borrow even more?(it might help of course, when these debts are refinanced in a way which decreases the average legacy interest rate).
But other kinds of QE are possible.
As far as I could figure out, national central banks have the right to define pension funds as ‘eligible counter parties’ (look here and here and here) which means that QE can also be used to buy bonds from pension funds instead of banks. And, contrary to banks, pension funds can use this money to invest in the real economy – or to pay pensions, which adds new money and purchasing power directly to the GDP economy. One can also think of some kind of ‘QE for the people’ which for instance consists of emitting transferable vouchers to each Eurozone citizen which can be used to pay down bank debt (mortgage debt, study loans) and which the banks can change into reserves at the ECB.
(the graphs are not entirely consistent, I’m working with a new version of Excel and I have not yet completely mastered the new graphing functionality)