Bond-buying plan entices Europe

Japan, now in recession, tried ‘quantitative easing’ strategy

Housing-rights activists confront police after the arrest of an activist and eviction of an 85-year-old woman Friday in Madrid. The European Central Bank is considering new moves designed to give some stability to the flagging eurozone economy.
Housing-rights activists confront police after the arrest of an activist and eviction of an 85-year-old woman Friday in Madrid. The European Central Bank is considering new moves designed to give some stability to the flagging eurozone economy.

FRANKFURT, Germany -- Japan's return to recession has renewed questions about the effectiveness of its recent monetary stimulus -- and how similar steps would help Europe's struggling economy.

The European Central Bank is edging toward the same kind of large-scale bond purchases that the Bank of Japan has used. Proponents say the measure, typically used as a last resort by central banks, could help strengthen the shaky eurozone recovery by reducing borrowing costs for businesses, households and governments.

Yet Japan's recession underlines the limits of so-called quantitative easing, which involves pumping newly created money into the economy through bond purchases.

The step may help keep the euro's exchange rate down, putting a lid on borrowing costs for the foreseeable future and generating some wealth effects.

However, few economists think it will provide a magic solution -- especially if governments such as those in France and Italy don't make their economies more business-friendly and if countries keep trying to reduce debt by reducing government services and social programs.

"The Japanese experience gives a very strong indication that if there is not enough demand sparked by fiscal policies or by structural reforms in the labor markets, it is very hard to see how monetary policy alone can achieve a reduction in unemployment," said Michael Koetter, a professor at the Frankfurt School of Finance and Management.

In Japan's case, proponents of bond-buying say the country's fall back into recession is mainly because of an ill-timed sales tax that hurt consumer spending. The U.S. Federal Reserve and Bank of England have also done bond-buying and seen their economies rebound.

After the European Central Bank cut rates and introduced programs this summer to increase bank lending to companies, it said it was ready to also consider such large-scale government bond-buying. President Mario Draghi said Friday that the bank is ready to "step up the pressure" if the economic situation does not improve.

Draghi said the central bank could broaden its current bond purchase program, which is now confined to bonds backed by bundled bank loans -- a more targeted effort to increase lending to companies.

The European Central Bank's next policy meeting is Dec. 4, although analysts think that if the central bank does act it may do so early next year.

The central bank has held off in part because it's harder to carry out such a program in a bloc with 18 members. The measure also faces opposition in Germany, where some fear it may reduce countries' incentives to reform and expose taxpayers to potential losses.

Still, many say the central bank is running out of options.

"This revival has already peaked," said Jean-Michel Six, chief European economist for ratings agency Standard & Poor's.

The most immediate impact of speculation that the central bank could start buying government bonds has been a sharp fall in the euro, particularly against the dollar. It's down from near $1.40 in May to around $1.25 now. It's classic supply and demand -- having more euros in circulation as a result of bond-buying would dilute the currency's value.

The lower euro is a potential positive as it makes the region's exports cheaper, leading to to growth.

A quantitative easing program would likely keep that pressure on the euro, providing a longer-term economic boost. And a falling euro could have an additional positive effect by raising import prices.

Falling prices sound good but in reality could further weigh on the economy as consumers delay purchases in the hope of bargains down the line and businesses put off investments.

If it were to start buying bonds, the European Central Bank would be doing so under very different conditions than those under which the Federal Reserve acted. It embraced the policy as a way of preventing the recession in the U.S. from becoming an outright, 1930s-style depression after the U.S. economy, like others, slumped in the wake of the 2008 financial crisis.

The Fed's stimulus helped drive down market interest rates. Growth rose and unemployment fell.

Yet many rates in the eurozone have already fallen to record lows, which decreases the impact of bond-buying.

Proponents of bond-buying say it's still worth trying, especially since the Fed is expected to start raising rates next year. Higher yields on U.S. Treasuries are expected to have a knock-on effect, lifting market rates around the world. A European bond purchasing program now, according to S&P's Six, could help "limit the contagion."

Business on 11/22/2014

Upcoming Events