Euro zone Monetary policy

It’s euro zone’s turn of QE

In my note on Jan. 18 last year, I wrote, “The ECB won’t be willing to see a persist low inflation, so I think it will likely take the opportunity to conduct more accommodative monetary policies … Following the footprint of the central banks of the U.S. and Japan, the ECB could conduct a QE program to pump up the equity market and the economy, given the progress made in the fiscal austerity, bank union and other financial regulations in the zone”.

Today, the ECB indeed launched its QE program for the very reason of ultra low inflation. In fact, it promised to keep buying assets until inflation is close to 2%.

I think the ECB took lessons learnt by the U.S. Fed. First is the size of monthly purchase. Latest U.S. QE program was $85B per month. The ECB will purchase about $70B per month, given the euro zone has the comparable GDP size to that of the U.S. The difference of $10B maybe due to German (accounting for 20% of euro zone’s GDP) which does not need QE. Second, it is open ended. U.S. conducted QE1 and QE2 between late 2008 and middle 2011 with preset amounts and it was found not effective enough to drive down unemployment and drive up the economy. Since September 2012, the Fed initiated an open ended QE which was proved to be powerful and effective and the U.S. economy has now good recovery.

The ECB set September next year to review the effectiveness of the program. I think the rationale is that it will take about eighteen months to fully transmit the monetary policy into the real economy.

The ECB is expected to purchase a total of $1.1 – 1.2T by September next year. I think it will have to extend longer. The QE program in the U.S. lasted about eight years with total purchase over $4T:

QE1 – late 2008 to early 2010, total $1.7T

QE2 – late 2010 to middle 2011, total $0.6T(Operation twist – September 2011 to end 2012, total $0.7T)

QE3 – September 2012 to October 2014, $85B per month (early few months was $40B per month and last few months were ramping down).

I guess the total QE by the ECB will be between 2-3 trillion dollars and will last multiple years. The effectiveness of the program, as recognized by the ECB, will be complicated by slow structure changes in the euro zone.