January 26, 2015
Late January has seen two important, highly-anticipated events unfold in Europe: the announcement by the European Central Bank of a large-scale Quantitative Easing program and the results of the Greek general election.
In the first — and by far the more important of the two — the ECB, faced with disinflation bordering on deflation, finally announced a large expansion of its asset purchases to include securities issued by central governments. It was the last to do so amongst the central banks of the developed world.
Financial markets were not disappointed as the scale (€1.1 trillion), pace (€60 billion per month), scope (securities issued by European agencies and institutions as well as sovereign bonds), and duration (at least until September 2016, and until inflation approaches 2 percent) of the program exceeded expectations. A compromise was struck regarding the apportionment of national sovereign risk to allay the fears of the wealthier countries that the bank might take on too much fiscal risk deriving from possible future government defaults or restructurings.
Only a fifth of the purchases will be subject to loss sharing. This might raise doubts about the existence of a “single” monetary policy. The acceptance of a partial mutualization of potential losses, however, is a significant step forward and adds another important milestone on the road to European integration alongside the creation of the European stability fund and the beginnings of a banking union.
Through this program, the ECB aims to sustain reduction of long-term interest rates in order to encourage investment; reduce the yield of sovereign bonds that will help the budgets of the euro area governments; reinforce the area’s banks’ balance sheets to spur more aggressive lending; and finally, even if not an explicit goal, weaken the common currency that should favor the competitiveness of European exports and allow some inflation importing.
As demonstrated in other economies like Japan, and as ECB President Mario Draghi tirelessly says, monetary easing alone — no matter how unorthodox or aggressive — cannot be relied upon to spur sustained economic growth without the support of the appropriate fiscal policy and structural reforms.
This is where the Greek election comes in. The mantra of fiscal policy in the euro zone since the crisis has been one of austerity to rein in the profligate policies that had led to a ballooning public debt in many countries. The budgetary adjustments since the crisis in the periphery countries have been harsh and have led, in the view of many, to higher unemployment levels and the rise of populist parties.
In Greece, the reduction in GDP and the unemployment level have reached Depression-level proportions. After winning the European elections last May, the radical leftist Syriza party won the general election on January 25 on the basis of an explicitly anti-austerity program. Syriza pledged to renegotiate the terms of the bailout agreed with Greece’s creditors.
The existing program of financial support expires at the end of February. Without further external aid, the new Greek government might run out of money by June. Greek bonds are currently ineligible for the new QE program because of limits on how much debt the ECB can buy from any single issuer. Greece will be left out until it makes a repayment of debt already owned by the ECB in
July. This should allow for the opening of negotiations between Greece and the Troika (EU, ECB, and the IMF) to find the most acceptable options to agree on a further reduction of the debt burden and an easing of fiscal policy.
The Greek election results could embolden other movements across Europe and will certainly add fuel to the debate on solidarity within the EU. But the risks of “contagion” are much lower than they were at the height of the crisis in 2012. Conditions in the euro zone are very different and markets are not nearly as worried about it: the yields of Greek sovereign bonds were the only ones to widen during the run-up to the election. Of course, a residual risk remains.
The introduction of the QE program and continued low oil prices should provide a real stimulus for the euro area. A more realistic approach to fiscal tightening may help increase confidence. A solution for Greece can be found. Time will tell if this generation of European politicians will find the courage and the political will to implement the structural reforms that — in time — can lift Europe out of its lethargy. Dante Roscini is a non-resident senior fellow in the Atlantic Council’s Global Business and Economics Program.