ECB and QE: Asking for sparkling water when all they will give you is the miserable punchbowl

Much is being made of the ECB Governing Council’s debates about whether it would ever be prepared to do Quantitative Easing, buying outright member state sovereign bonds.  Draghi and a majority seem in favour of it, but not yet.  It is speculated that about 10 maybe against.

Yet the ECB has already determined to embark on credit easing – taking onto its balance sheet up to 1 trillion euros of private sector assets.

A characterisation of the critics of BoE and Fed unconventional policy is that it was too much focused on buying the assets where one would expect there to be the smallest amount of stimulus resulting.  QE is an exchange of assets that are more similar than in the case of credit easing.  Event study and other analysis showed pretty consistently that buying government securities did raise their prices (lower yields).  But at the same time the evidence that this fed through to the prices of private sector securities is more mixed.  [Some work finds that QE simply increased spreads].  And in the Fed case there is evidence that the purchases of Federal agency debt, a security less liquid despite the explicit nature of post-crisis government guarantees, was more stimulative than purhcases of Treasury debt.  And we don’t know if any of these effects on yields were long-lasting, beause of the difficulties of disengangling the other influences (not least the issuing feast that took place at the same time by the other arms of the public sector).

The standard response to this critique was to accept that buying private sector assets was more stimualtive in the short run, but that it ran too great a risk with the central bank balance sheet, threatening the independence of the central bank, relying on an untested expertise in assessing credit risk, leaving it open to accusations of collusion with the private sector issuers (who might be dinner party guests of the Governors), and so on.

Strange, therefore, that the ECB having embarked on this central bank radicalism – buying private sector assets – is at the same time being bashed for not wanting to do what will really fix the problem, a bit of old fashioned debt management.  (Swapping one default-risk free, zero interest security – reserves – for another – member state debt).

Ah, one might say, therein lies the rub.  The member state debt is not default risk free.  So perhaps QE should in that case be viewed as more radical a step as regards redistributing credit risk.  Although there is no private-to-public risk transfer, there is a redistribution of already socialised risk from sovereigns that can’t bear it to those that can.

If that’s the argument, then two questions follow.

First, why can’t the sovereign risk be alleviated by the credit-easing purchases of the private sector debt?  Since it is in large part the worry that those sovereigns are ultimately on the hook for the private debt that causes them difficulty.  [Either because of an expectation of bailout, or being sunk by the workings of automatic stabilisers if private defaults mounted and local recessions deepened.]

Second, the argument that QE is helpful to alleviate sovereign risk impies that the promise to ‘do whatever it takes’ under the auspices of the Outright Monetary Transactions program isn’t enough.  I argued before that this promise was a bluff.  [Because there was no support to take the implied unbounded risk to the ECB’s owners].  But the consensus has been that it wasn’t or that it was a bluff that worked.  But if OMTs have worked, then the argument that QE is necessary to tackle sovereign risk is weak.

Current complaints are like booing because the central bank, just when it sees the party getting going, shouts that everyone should glug as much from the punchbowl as they can, but refuses to serve any more sparkling water and tomato juice.

 

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