Quantitative easing: how Mario can tackle low inflation in Eurozone

Mario Draghi, President of the European Central Bank (EC Audiovisual Services)

One of the major issues that the European Central Bank (ECB) struggles to solve is low inflation. It seems that it is not even close to the target that has been set; a rate of below but close to 2% over the medium term. April’s inflation data indicated a 0.7% inflation rate, a percentage not far away from deflation levels. If we also add European economy’s thin growth outlook, it is more than obvious that an alternative measure has to be taken by ECB.

Quantitative easing: a just around the corner policy

Mario Draghi, ECB’S president hides an ace in his sleeve to deal with low inflation that has not yet put on the table. This is called quantitative easing (QE) and is an unconventional monetary policy that the central bank will surely discuss on the 5^th of June when the bank’s governing council will meet. This was basically derived from his ‘almost’ pre-announcement during the meeting on May 8 where he mentioned that harder action would follow in June. Evidence of this started appearing in real market where the euro depreciated against the US dollar reaching levels below $1.36 on May 28.

Moreover, the major European stock indices (CAC 40, DAX 30 and FTSE 100) rose showing a psychological sentiment that this policy will be implemented. The only thing though that Mario Draghi waits for is the growth and inflation forecast from ECB’s economists which will not take long to come. But the question that comes to everyone’s mind is: will this policy be able to tackle the issue?

The pros and cons of this strategy

On the one hand, the central bank is trying to lower interest rates and increase the money supply through QE. The idea is to increase lending and liquidity levels by flooding financial institutions with money. Therefore, many businesses and households will take advantage and especially SMEs which need it the most.

On the other hand, there are risks that must not be taken lightly. First, the policy could work in a more efficient way it was supposed to because of increased money supply and drive inflation to levels higher than the ones targeted which eventually will reduce the purchasing power of people’s money.

The other risk lies on the opposite site compared to the previous one. The problem comes when the banks don’t lend out the extra money taken by the central bank leading to QE’s ineffectiveness. Therefore, if ECB is about to take bolder decisions and put this policy into force they will have to think twice because not only the risks but also the side effects might be worse than the non-implementation.

It is clear that European citizens will be the ‘guinea pigs’ in this procedure and since past policies’ mistakes have proven devastating for entire countries, ECB must be very careful in each and every step that it makes. However, we have to admit that ECB expected attempt is coming after first trying other alternative and less harsh measures.

European elections outcome and ECB’s limits

The eurosceptic message that people passed through with their vote in last weekend’s elections is an issue that national governments and the European parliament need to pay attention to. What European citizens showed is that they only care about job creation and lasting growth and prosperity.

Those will not come easily even if QE works out after all. This means that ECB does not have the absolute and everlasting solutions in its magic box. A permanent antidote in this case, which was actually implied by the simple voters, must be given by each government separately. National governments must create policies that will help the economy be more productive and competitive, which will boost growth further and not just count on the ECB tricks.