The Shortcomings of Quantitative Easing in Europe

CAMBRIDGE – Why has the US Federal Reserve’s policy of quantitative easing been so much more successful than the version of QE implemented by the European Central Bank? That intellectual question leads directly to a practical one: Will the ECB ever be able to translate quantitative easing into stronger economic growth and higher inflation?

The Fed introduced quantitative easing – buying large quantities of long-term bonds and promising to keep short-term interest rates low for a prolonged period – after it concluded that the US economy was not responding adequately to traditional monetary policy and to the fiscal stimulus package enacted in 2009. The Fed’s chairman at the time, Ben Bernanke, reasoned that unconventional monetary policy would drive down long-term rates, inducing investors to shift from high-quality bonds to equities and other risky securities. This would drive up the value of those assets, increasing household wealth and therefore consumer spending.

The strategy worked well. Share prices rose 30% in 2013 alone, and house prices increased 13% in the same twelve months. As a result, the net worth of households increased by $10 trillion that year. The rise in wealth induced consumers to increase spending, which restarted the usual expansionary multiplier process, with GDP up by 2.5% in 2013 and the unemployment rate falling from 8% to 6.7%. The expansion continued in subsequent years, bringing the current unemployment rate down to 5% – and the unemployment rate among college graduates to just 2.5%.

The ECB has been following a similar strategy of large-scale asset purchases and extremely low (indeed negative) short-term interest rates. But, although the policy is the same as the Fed’s, its purpose is very different.