11 questions you are too embarrassed to ask about Quantitative Easing

Things like: what exactly is Quantitative Easing?

Russell Lynch
Thursday 22 January 2015 16:47

European Central Bank president Mario Draghi has taken the Eurozone into uncharted territory today as rate-setters agreed to pump €60 billion (£45.5 billion) month into the eurozone economy.

Mr Draghi has already cut interest rates to a record low of 0.05 per cent and attempted to boost lending by offering cheap loans to banks, but growth remains sluggish - just 0.2 per cent in the last quarter - and inflation turned negative for the first time in more than six years in December, with prices falling 0.2 per cent year on year. Mr Draghi will keep up the programme until March 2016, taking a €1.1 trillion gamble that the move will revive Eurozone growth.

What is it?

The clue’s in the name. It is, quite literally, when a central bank - like the ECB today - attempts to boost growth by increasing the amount of money in the economy when they’ve cut interest rates as far as they can go.

How does it work?

They don’t actually print money or lob it out of helicopters. A central bank creates money electronically, and uses to it to buy the debt (called bonds) that countries issue to pay their bills from institutions like insurers pension funds.

What happens then?

Buying up all that debt pushes down interest rates on the bonds and other financial assets - making it cheaper for companies to borrow and invest, increasing spending and job creation.

Will the extra money cause inflation?

With the cost of living in negative territory, Mr Draghi would love a bit of inflation - that’s the point. Too much deflation and businesses can delay spending decisions, sending the economy into a spiral of stagnation and falling prices. Inflation in the eurozone is -0.2 per cent, compared with the ECB target of 1.9 per cent.

What does it mean for me?

Cheaper holidays in Europe. All those extra euros sloshing around the financial system means the pound buys more euros. Sterling shot up more than 1c against the single currency to €1.3181 following Mr Draghi’s announcement.

What about the UK?

UK companies who export around 40 per cent of their goods to the eurozone should benefit from a brighter European economy, despite the stronger pound.

Who else has done QE?

The Bank of England and the US Federal Reserve launched QE early in the financial crisis in 2009, but the ECB is playing catch-up. This is partly due to the complexity of doing it across several countries at the same time, and partly because the inflation-wary Germans have been opposed.

Why don’t the Germans like it?

The Germans are against it because they think that QE from the central bank is just offering a sticking plaster to weaker economies like Italy and Spain, who need to push through economic improvements like a more flexible jobs market to improve competitiveness.

Has Draghi listened to them?

Yes. Although he’s gone ahead with QE, the way he’s done it means that individual central banks will be liable for losses on 80 per cent of the bonds bought. That way, Germany wouldn’t have to pick up the whole bill for any losses on, say, Spanish bonds.

Will QE work in the eurozone?

Difficult to say. €1.1 trillion sounds like a lot of money but it’s only around 10 per cent of the eurozone economy. The programmes undertaken by the BoE and the Fed were much bigger. But a less valuable euro will also help eurozone exporters.

Is it legal?

Printing money to finance Government debts is illegal under European Union treaties. But the ECB says QE is a purely monetary tool, in line with its mandate to ensure stable prices.

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