On 12 September, the outgoing European Central Bank (ECB) president, Mario Draghi, announced that he would cut interest rates and continue the central bank’s bond-buying programme. This was in response to the looming recession in Europe and has triggered a fierce debate in the Eurozone between monetary hawks and doves, as well as EU politicians and technocrats, over the role of monetary policy in the post-crisis world.
Draghi’s announcement is another sign that Europe may be headed the way of Japan, whose economy has been propped up for nearly two decades by an unending quantitative easing (QE) programme. In the wake of the collapse of its own housing bubble in 1991, the Bank of Japan first started exchanging digitally-created money for government bonds in 2001. The central bank’s balance sheet has now reached 100 per cent of GDP.
In the immediate aftermath of the 2008 financial crisis, few central bankers foresaw such an outcome for Europe. Central banks in the US, the UK and Europe assured onlookers that QE would be a temporary measure to boost lending. Many economists at the time, such as Richard Murphy, were sceptical that central banks’ coordinated easing programmes would affect the economies in which they were deployed by raising bank lending – instead they argued that QE might help to prop up demand by boosting asset prices.
The sceptics were right. There is now strong evidence that QE works by boosting asset prices. Central bank purchases have a direct impact on bond yields and also encourage investors to rebalance their portfolios towards other assets, such as equities or corporate bonds. The resulting surge in demand for these assets has increased equity prices, depressed corporate bond yields and pushed up real estate values in some cities.
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