Can This One Weird Trick Save Europe’s Economy?

Super Mario, sans overalls.


This morning, Mario Draghi finally fired his bazooka. At least, that was the somewhat phallic metaphor finance Twitter and the press settled on to describe the new and aggressive bond-buying program, known as quantitative easing, that the European Central Bank president hopes will help salvage the eurozone’s broken economy. Starting in March, Draghi announced at a news conference, the bank will effectively print money to buy €60 billion worth of public and private assets per month through at least September 2016, spending more than €1 trillion.1 The plan is bigger and bolder than many expected. Which is why it’s inspiring bang-up Photoshop jobs like this.

And this.

Anti-tank imagery aside, though, don’t expect to see too many explosive effects from this effort.

The eurozone’s economy has been in such awful shape for so long that it has become easy to forget just how dire the situation really is. Although it climbed out of a recession in 2013, the region’s gross domestic product is barely growing. Overall unemployment is stuck above 11 percent, while in Greece and Spain, more than a quarter of workers are out of a job.

To make matters worse, the common currency area is now staring at deflation, which can suck an economy into a destructive downward spiral. When prices fall, families tend to put off spending (why buy today when that washing machine will be cheaper tomorrow?), debts become harder to repay as the relative value of old loans grows, and companies tend to hold off on raises for their workers. Last month, prices declined 0.2 percent. Part of that was due to the collapsing cost of oil—which is generally a good thing—but if they tumble further, it could spell more long-term trouble.

The imminent threat of falling prices seems to be what finally allowed the ECB to overcome objections by inflation-phobic Germany and launch its stimulus program. By purchasing government bonds in bulk, it hopes to drive down their interest rates and encourage investors to buy riskier assets like corporate debt and stocks. Convincing more people to get in the market for corporate bonds could theoretically lower the cost of borrowing for companies that want to invest while rising stock prices might make everybody feel wealthier, and spend. By metaphorically turning on the presses, the ECB will also push down the value of the euro, which should help countries sell more exports, and stimulate their economies.

The end goal: Nudge inflation back toward the central bank’s target of slightly less than 2 percent.

Importantly, the ECB has said it will keep on buying bonds for as long as it takes to get the job done, or “until we see a sustained adjustment in the path of inflation,” as Draghi put it. That open-ended commitment is a signal that Super Mario (as he’s affectionately referred to) & Co. are dead serious about this effort. The more serious the ECB seems, the more likely inflation expectations will rise, and the more likely actual inflation will follow.

With that said, it’s not clear how much good bond-buying can do for Europe at this point. The United States Federal Reserve and the Bank of England both resorted to quantitative easing, or QE, back in 2009 (the Fed just finished its third and final round in November). And while the policy is often credited as one reason the U.S. recovery has been far stronger than Europe’s, nobody knows for sure exactly how much good it did. On the one hand, our economy managed to continue expanding despite cuts to state spending and sequestration. On the other, the early years of the recovery weren’t exactly a period of torrid growth, and inflation has stayed low. Crafty central bank intervention wasn’t necessarily a cure-all. And nobody should expect it to single-handedly fix Europe’s far, far deeper economic troubles.

There are also reasons to think that the eurozone version of QE will be less potent than the U.S. edition. One, as the Financial Times highlights, has to do with the way European companies finance themselves. In the U.S., corporations largely borrow by tapping debt markets, which is why lowering bond rates is helpful for them. In Europe, companies borrow directly from banks that, even with easing, might not be interested in lending to them (they could, for instance, just buy U.S. treasuries). Beyond that, government interest rates in much of the eurozone are already quite low—in Germany, they’ve been at record lows, in fact. But that hasn’t stopped investors from piling into them, and it’s not obvious that pushing them down a bit further will dissuade them in the future. Meanwhile, whereas the Federal Reserve took investors by surprise when it began easing, the markets have been anticipating some sort of move from the ECB for a while, and may have priced much of its effects in.

There are also some arcane-sounding details of the program that could blunt its effect. For instance, rather than purchase government bonds from the most troubled economies, the ECB will buy bonds from each country in proportion to the amount of capital they hold at the central bank. The upshot of that completely numbing sentence (I apologize) is that it will be buying a lot of German debt, with its already low interest rates, and may simply convince banks to look for alternative investments in Germany rather than, say, Italy.

The ECB’s program is still a worthwhile effort. The bank needs to do something to revive the eurozone, and quantitative easing is the biggest untried tool in its arsenal. But as Larry Summers put it at Davos, “necessity should not be confused with sufficiency”—monetary policy alone isn’t going to save countries like Italy, Spain, and Portugal. Unfortunately, Europe is still largely focused on reducing debt, rather than using fiscal stimulus, and reforms that would fix its calcified, uncompetitive labor markets in the most troubled countries are slow coming.

Point being, nobody ever won a war with a single bazooka. Nobody should expect Draghi to, either.

Footnote1: Despite its popularity, some people object to the phrase “printing money” to describe QE, because in real life it involves creating electronic bank reserves, which isn’t the same as just pouring a bunch of euros into the real economy. That actually has some meaningful policy implications, but for our purposes today, it’s not exceedingly important.