Synopsis:  The ECB and how it avoids QE.

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Discussion:

This article discusses the fact that the ECB is taking negligible steps towards helping the Eurozone economy in terms of monetary policy.

The ECB is facing major opposition from Germany, which fears that the launch of large-scale and proper QE might result in uncontrollable hyperinflation – a repeat of pre-World War 2 German economy.

As opposed to the QE that was used by the Fed and is being used by the BoJ, the ECB is instead enacting ‘penance’ measures – more to put up a show rather than to improve the economy, according to Pritchard.

Mr. Mario Draghi, the head of the ECB, has hinted at a EUR 1tn spend. As much as it sounds similar to QE, it is not, for two major reasons:

1) Central banks that enact QE take the risk on their own balance sheet; this is to say, whatever happens to the value of the sovereign bonds they purchase, they deal with it. Instead of doing so, they are offering LTROs (explained in the article) to banks in exchange for collateral.

2) The ECB is spending nowhere near the EUR 1tn promise – rather, its spending amounts to about EUR 450bn, perhaps lower. This equates to roughly EUR 17.5bn a month (and this spending will not start until the end of the year), 10 times less than the spending by the Bank of Japan.

Many economists also say that the lowered interest rates will have a negligible effect on the overall market at this point, i.e. conventional expansionary monetary policy just does not work for the Eurozone as of now.

Key terms:

1) Deleveraging: Where banks lower the amount lent to the public so that banks can keep up with the capital adequacy ratio.

2) Capital adequacy ratios: To protect bank depositors, governments have come up with this concept. The idea is that a bank must have a certain amount of capital in its bank, so that if the bank incurs losses and cannot pay depositors back, the banks can use some of its own capital to cover the losses. Usually, when capital adequacy ratios are discussed, the Basel rules are mentioned as well. These rules (Basel I, Basel II and Basel III) dictate the amount of capital needed in the banks. The more, the better for the depositors.

Context:

One thing worth discussing is the sixteenth paragraph: “Nor is it clear… said Mr. Roberts from RBS”. The statement being made here is that unless the ECB takes on bad bonds, there is no point in bothering with QE in the EU. The problem with this statement is that no economy that has practiced or is practicing QE (Japan, USA and UK) has taken on bad bonds; they have only ever taken sovereign (government) bonds. Government bonds are steady and trustworthy, and very reliable bonds to purchase. For a long time, the government and the central bank of a country have been split, where it is the government’s job to take on bad loans and liquidate frozen banks. The central bank has two objectives: to maintain steady and reasonable inflation, and to reduce unemployment. If an economy were to be taking on “bad stuff”, as Mr. Roberts from RBS (quoted in that paragraph) says, it would be only from the part of the individual governments, not the ECB.

Synopsis: The abysmal state of the Italian economy and how it can recover.

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Discussion:
This article discusses the dismal state of the Eurozone, focusing on Italy, and stresses the importance of QE as a means of recovery.

Many economies are doing abysmally, such as France, Germany and Italy, all of whoom had great hopes of recovery. As GDP in Italy slows down to 0.1% and debt rises, the debt/GDP ratio rises to 145%.

The high debt/GDP ratio worry many, and the writer, Ambrose Evans-Pritchard, calls upon Mario Draghi (the head of the ECB) to start QE in a serious way, as opposed to the timid plans that are being discussed by the ECB.

Italy is now practicing contractionary fiscal policy to lessen its high debt.

Zolt Darvas, quoted in the article, rom the Bruegel think tank in Brussels, warns that relying on additional lending by ECB will do minimal good. Instead, QE, in the form of asset purchases, is needed to stimulate the economy.

Whether or not Italy’s current prime minister, Matteo Renzi, will “meekly” participate in further austerity and fiscal cuts, one thing is clear: only if the ECB begins QE in a meaningful way will the Italian economy be saved.

Key words:
1. Primary budget surplus (paragraph 10): This is where the Italian government is in surplus when the government pays back the principal borrowed, but not the interest. Once the Italian government pays the interest back to its lenders, it is facing a deficit. The solution to this is austerity measures, which allows them to stop borrowing but maintain some reasonable level of government revenue through the collection of taxes. A good analogy is found here.
2. Debt trap (paragraph 12): A debt trap is where a country borrows to pay back interest. For example, if Italy borrowed 10 billion euros with 2% interest rate per annum (not real figures), and Italy pays back the 10 billion euros at the end of the year but not the 200 million euros interest, it will borrow more money to pay back the interest. The new loan will come with its own interest rate, which Italy must pay back by borrowing from somewhere else. Ultimately, Italy will spiral into uncontrollable debt.
3. Anglo-Saxon QE (paragraph 15): U.K. and U.S. QE
4. Austerity measures: This is contractionary fiscal policy, which means an increase in tax rates and a decrease in government spending. This is usually used to reduce the debt level in a country.

Context:
1. Internal vs. external devaluation: Neither of these terms is explicitly said in the article, but both ideas are mentioned. External devaluation is when an economy’s currency is devalued, which will encourage exports and hopefully increase production in the economy. Italy, being a part of the EU cannot devalue its currency as it does not have its own currency to control. Hence, exports cannot be encouraged through external devaluation. What Italy can do is devalue its economy internally. In paragraph 17, Evans-Pritchard writes, “If Italy slashes wages and deflates the economy to further regain lost competitiveness…” This is internal devaluation. By slashing wages, there will be less for Italian citizens to spend. Because of this, the price of commodities will drop. This drop in price of commodities might encourage other countries to import goods from Italy. It is a risky game, because it increases unemployment. Hence, internal devaluation is always a second-resort option; most economies prefer external devaluation.
2. Debt/GDP ratio: this is the ratio between debt and GDP. No economy ever looks at debt on its own, because it must be in relation to its economy. Imagine Country A with $100 debt and Country B with $200 debt. While it seems like Country A is doing better, this might not always be the case. Country A has only made $10 GDP, while Country B has made $100. So, Country A’s debt is ten times the amount of its GDP but Country B’s is only twice. On this scale, Country B is doing much better. This is why debt is always taken as a ratio of GDP.