The European Central Bank (ECB) announced Friday it would start buying 60 billion euros worth of bonds from banks each month until the end of September 2016, or longer, in a step called quantitative easing (QE).
QE in theory increases the supply of money, something that keeps interest rates low and encourages borrowing and therefore spending. Here's how it works.
The central bank creates money, which will be used to buy bonds from financial institutions, this in turn will bring interest rates down and spur lending to businesses thus helping people to borrow more. This in turn should enable people and businesses to spend more boosting the overall economy.
But what has been the record of recent QEs in creating growth? The US Fed unleashed its third and biggest QE in September 2012. US growth in 2102 was 2.3 percent, 2.2 percent n 2013 and 2.4 percent in 2014.
Japan unleashed its QE in April 2013, with the BOJ agreeing to add 60-70 trillion yen in a year. What is Japan's growth? Japan's GDP was 1.5 percent in 2013 and fell to 0.2 percent in 2014.
Recent QE's have not created growth but they have ruffled currency markets. From September 2012 when the US announced its QE3 up to May 2013 when the Fed decided to end QE, the dollar fell from 1.2 to the euro to 1.4, a fall of about 15 percent.
In April 2013 when the Japan QE was announced, the yen was 93 to the dollar, post its QE it has fallen to 118 to the dollar, a fall of 25 percent. Clearly QEs impact markets more than they impact the economy.
To discuss the impact of the ECB QE on the economy and on the markets, CNBC-TV18's Latha Venkatesh spoke with Manoj Pradhan, Global Emerging Markets Economist at Morgan Stanley and Ankit Gheedia, Equity Derivative Strategist at BNP Paribas.
Below is the transcript of Manoj Pradhan and Ankik Gheedia's interview on CNBC-TV18.
Q: Do you think there can be an economic impact at all in Europe because of the QE?
Pradhan: They have already had a series of measures to increase the balance sheet and expand monetary policy impetus into the economy. Don't forget we have had a series of long-term refinancing operations (LTROs) and main refinancing operations (MROs), which have pushed liquidities back into the system.
The banks then use part of that money to buy government bond yields. We had the very famous speech by [EBC chief Mario] Draghi, in which he promised to do "whatever it takes" and that together did bring down yields substantially. So, this is not the first installment of QE.
One of the concerns about the impact is whether it can further bring down yields which we have seen it do. It has brought down the euro but most importantly it gives a very strong signal about monetary policy intentions. We call this kind of QE where the central bank balance sheet has expanded proactively as active QE and that tends to give a pretty good signal about monetary policy intentions.
Q: It did certainly reduce yields and practically pulled some of the potentially exiting nations back from the brink but did it really improve the economy? We only see Eurozone getting into near deflationary status and even near stagnation. Do you see any economic improvement because of this 1.14 trillion euros?
Pradhan: There will an impact. How strong is questionable, because what is the role of monetary policy? The basic role of monetary policy is try and smooth cycles out. It cannot change the structure of the economy. If you are trying to compare, say, the US economy to the European economy, the latter has significant structural hurdles.
Part of the reason that is going into a disinflationary and deflationary period is because some of the structural impediments have not been cleared. Monetary policy cannot clear them, but what it can do is it can try to anchor monetary policy and inflation expectations to a higher level and if those inflation expectations are raised to a higher level then deflation and debt deflation then becomes a slightly smaller problem.
So, it is not that you can solve the economy's problem but you can give it cyclical momentum that can persist for a period of time. Now what the economic impact will be depends on how far yields can go and as I said since yields have already moved down the marginal impact on this might be more a signal that says look, we will do pretty much everything that we can to make sure that inflation expectations move up.
So, yes, there will be an impact, how strong is frankly debatable but keep in mind that as the QE announcement has come in -- the growth story was already starting to lift. The purchasing managers indexes (PMIs) have already come in stronger.
I don't think we should be attributing this to QE but it might be happy coincidence that the impact on oil prices also brings economic growth a little bit better than most people expect.
