When the European Central Bank (ECB) on January 22 launched its long-expected expansion of its quantitative easing (QE) program, the world markets looked on with hopeful eyes. Seeking to spur growth and raise European inflation to around 2 percent, the ECB’s plan is simple. Every month starting in March 2015, the ECB will buy approximately €60 billion in government-back bonds from each of the nineteen Eurozone countries. The plan is expected to last until September 2016 at a minimum with thoughts that if the ECB’s inflationary goal is not reached, the plan would continue. Overall, an expected €1 trillion in assets is expected to be bought by the ECB. Said ECB President Mario Draghi, “Expectations work only if there is a certain credibility. Today we are showing that credibility is deserved” For “Super Mario”, he is hoping that his plan will deliver upon early promises.
The ECB is not revolutionary in its implementation of QE. Although relatively new, QE has been a tool used by numerous central banks in an effort to revitalize economic growth in the wake of the 2007-2008 Financial Recession. First used by Japan in the early 2000s to spur growth, The United States’ Federal Reserve was the first central bank to launch QE after the financial crisis of 2007-2008. Recently ceased by the Fed in October 2014, it is too early to study the effects of QE in the United States. As reported by the New York Times, the Fed saw its balance sheets rise to approximately $4.48 trillion in assets, in addition to the equity markets nearing pre-recession figures, as the Dow Jones and the S&P 500, for example, saw record numbers hit by the end of 2014. However, while American unemployment has fallen to approximately 5.7 percent as of February 6 and workforce participation is nearing pre-financial recession figures, inflation still remains far below the Fed’s goal of 2 percent inflation. The jury remains out on QE and the ECB could be taking a large risk in implementing this policy.
There are, however, potential pitfalls that are unique to Europe. For starters, unlike the United States or Japan, the ECB is not dealing with one country: it is dealing with nineteen. While all the countries share the euro, all nineteen countries are not the same economically. While countries such as Germany and France remain some of the largest economies in the world, other countries such as Cyprus and Malta are some of the smallest. The ECB must balance the intricate differences in the nineteen economies. In addition to the fact that some of the countries, such as Italy, Greece, and Spain are either in the midst of further economic downturns or are still in the process of coming out of the financial recession. Countries such as Germany are fearful about sharing in the suffering of the other member states, as the idea of risk sharing does not sit well with the stronger Eurozone economies. The ECB attempted to reduce this issue by making only twenty percent of the ECB’s assets shared risk across all the Eurozone. The other eighty percent of assets will be held by the individual national banks in an effort to have each country shoulder their own debt and, in case of financial downturn, not bring the rest of the Eurozone down with it. Furthermore, as reported by The Financial Times, the assets will be bought in proportion to the size and strength of the Eurozone countries. By shifting the responsibility to the national banks and having them buy their own national debt, the ECB is hoping to ensure similar success to other QE programs while reducing the overall risk. While it still has not entirely satisfied the austerity focused Germans, this concession did allow for overall passage.
There remains another problem, one that extends far beyond simple economics. Greece, the nation that started it all with an overabundance in government and public sector spending, wants to be absolved of most of its debt owed to other Eurozone countries. Furthermore, it specifically aims its frustrations at Germany’s insistence that Greece must implement austerity measures in order to receive its bailout funds. So great was the outcry that on January 25, only days after the ECB announced its QE program, Greece voted for and elected a new Parliament. Replacing the neutral-leaning austerity government is the far left-wing Syriza party, headed by Alexis Tsipras. Directly challenging German austerity measures, Mr. Tsipras has stood firm in his belief that Greece should be absolved of most of its debt and should be allowed to return to its pre-recession spending habits. Furthermore, his selection of Yanis Varoufakis as Greece’s new financial minster also worried many European countries due to his Marxist-leaning ideology. Mr. Tsipras and Mr. Varoufakis toured across Europe, touting potentially new deals to be reached that would remove the stringent austerity measures placed upon Greece. While some, such as Francois Holllande of France have been more receptive, others, such as Germany’s Angela Merkel, have not. In short, Greece and the ECB are on a collision course, one that could have far reaching consequences.
Why Greece remains important in this debate is the potential “Grexit”. Greece no longer is willing to continue austerity and directly challenges Germany’s final word over the Eurozone’s economic policy. While the European economy as a whole is far stronger than it was when the first thought of “Grexit” sprung up in 2011-2012, there are large ramifications if Greece were to leave the Eurozone. For starters, the rise in populist countries among countries in the midst of bailout plans, such as Spain, is concerning. Syriza’s blatant attack on austerity could embolden other anti-austerity movements throughout the European continent. These populist movements are hoping to return their respective nations back to their old economic patterns, as they view austerity as a direct threat and one that has caused unnecessary economic hardship. If Greece were to leave the Eurozone, there is nothing to stop other countries like Spain from doing the same. This would throw convention to the wind, as most believe that a country cannot leave the Euro once it has entered. Theoretically, the Euro could be dissolved and the European Monetary Union would be reduced to nothing. Furthermore, as cited by The Economist, much of Greece’s current €300 billion in debt is held by the ECB, the IMF, and the European Financial Stability Facility, which serves as the EU’s crisis-resolution fund. If Greece were to decide to leave the Eurozone because of default, the European financial system would be greatly weakened and would encourage other indebted countries to do the same. For Greece, however, the consequences of such a move would be destructive to their own economy. A new Greek currency would be extremely weak compared to the Euro, triggering high inflation and costly imports. Furthermore, as The Economist stated, Greece would more than likely default due to the inordinate increase in size of its foreign debt.
There is a need for compromise on both sides. Greece cannot be expected to pay back all of its debt. Currently at 175 % of GDP, Greece’s debt is unpayable and has been marred by recession throughout the austerity program. The ECB, for example, recently extended €5 billion in emergency loans in an effort to keep Greek banks from running out of reserve funds. As The Financial Times reported, the ECB felt the need to extend the emergency loan to Greece due to the steady withdrawal of approximately €200 to €300 million a day during the week of February 8th. It is clear that austerity in Greece cannot continue to move as planned. Countries such as Germany must accept that they will not receive all of their money back but should accept receiving a reasonable, but smaller, amount than they had hoped. One such proposal, supported by The Economist, is a “GDP-linked bonds” plan that Mr. Varoufakis recommends, in which the amount Greece would have to pay back to their creditors would be based on Greece’s own economic prosperity. However, Greece must be willing to keep some of the privatization policies that have been in place, such as reduced private sector spending and holding off on a proposed minimum wage hike. Mr. Tsipras, for example, must hold off on his proposed €2 billion welfare program, as to reinstitute Greece’s old welfare state model would severely hamper the progress Greece’s private sector has made. Greece currently cannot function soundly and will be brought further into economic recession if it fails to tighten its belt. In short, perhaps the greatest impact of the ECB will be what road it potentially leads Greece’s relationship with Germany on. Super Mario may have to find another trick up his sleeve.