Tuesday, March 31, 2015

31/3/15: QE for the People

ECB's QE programme launched this month is targeting wrong policy and likely to fuel an already massive bubble in stocks and bonds. It is also unlikely to help generate real economic growth, as it simply transfers more wealth to the financial markets.

Look at the facts: 
  • The Eurozone is suffering from structural stagnation that is driven by the lack of investment, anaemic domestic demand and policies, including taxation and enterprise regulation, that reduce entrepreneurship and make jobs creation and productivity growth (especially Total Factor Productivity) excessively costly.
  • Overall household and corporate indebtedness in the Euro area remain high despite several years of deleveraging.
  • Bank lending markets fragmentation contrasted by booming equity and bond markets shows that the problem is not in the lack of liquidity, but in over-leveraging present in the economy.

Experience in other countries that recently deployed QE shows that current measures by the ECB are unlikely to provide sufficient stimulus to drive growth to the new (and higher) ‘normal’: 
  • Japan, the US, and the UK experiences with QE show that monetary policies are useful to the real economy only when they are combined with either expansionary fiscal policies or real investment increases or both.
  • Even in such cases where QE has been successful, sustainability of QE-triggered growth has been weak in the presence of structural debt overhangs (Japan) and had to rely on structural drivers for growth present prior to the deployment of QE (the UK and the US).
  • In the Euro area, the idea is to combine QE with austerity policies and in the presence of dysfunctional financial markets. Such a program could increase misallocation of resources via bidding up financial assets prices over and above their long term fundamentals-justified levels. 
  • Bank of England created £375bn over the course of its QE programme. By the Bank of England’s own estimates, QE in the UK pushed up share and bond prices by around 20%. But because around 40% of stock market wealth is held by the wealthiest 5% of households, QE has made that wealthiest 5% better off by around £128,000 per household. 
  • You might want to check this post on the potential effects of QE on the real economy: http://www.zerohedge.com/news/2015-03-28/finally-very-serious-people-get-it-qe-will-permanently-impair-living-standards-gener 

In short: the QE, as currently being carried out by the ECB, benefits the less-productive holders of financial assets, not the poor, nor the entrepreneurs, nor the real enterprise.

There is an alternative policy, a policy of “Quantitative Easing for the People”, an idea of distributing QE money directly to the citizens of the Euro area.

This is a more efficient approach for stimulating the real economy precisely because it puts liquidity directly at the point where it is needed most and can be used most efficiently, absent intermediaries, to address real structural problems present in the economy.

The plan is identical to the ECB current plan in terms of funds allocated: €60 billion will be created each month for 19 months. The amount each national central bank will create can also depend on its share of capital in the ECB, just as the current ECB QE programme envisages.

Each Eurozone citizen can receive ca €175 on average each month for 19 months. 
  • The funds are taxable income, so there is a benefit to the Exchequers, allowing the governments to engage in expanded investment programmes or more efficiently close some of the budgetary gaps, while buying more time to implement structural reforms.
  • The funds (net of tax) can be used by households to accelerate debt deleveraging and/or repair their pensions funds and/or fund consumption.
  • As the result, “QE for the People” will stimulate domestic demand (consumption, investment and Government investment), while increasing the rate of debt deleveraging.
  • In addition, “QE for the People” can help improve banks’ balancesheets by increasing loans recovery (as households repay loans). In contrast, ECB QE will not have such an effect as it will be taking off banks balancesheets zero risk-weighted Government bonds.  Thus, “QE for the People” can be seen as a more efficient mechanism for repairing financial system transmission mechanism than ECB own QE policy.
  • The quantum of stimulus implied by the “QE for the People” proposal is significant. Take Ireland, for example. “QE for the People” means annual benefit of around EUR8 billion in direct stimulus (depending on how Ireland's share is estimated). In 2014, Irish Final Domestic Demand grew by EUR6.15 billion. So the direct effect of this measure for just one year would be equivalent to more than full year worth of real economic growth.

19 economists from across Europe and outside signed last week’s FT letter proposing this plan (with some variations) to stimulate the real economy in the euro area. The original letter is available here: http://www.basicincome.org/news/2015/03/europe-quantitative-easing-for-people/

This note posits my personal view of the alternative policy, somewhat at variance with the letter itself on the specific modality of Government involvement in the funding and Government receipt of the QE funds over and above normal tax capture (which I do not support). 

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