Fed’s Bullard recommends Euro Zone consider QE

Thursday, 23 May 2013 00:00 - - {{hitsCtrl.values.hits}}

FRANKFURT (Reuters): A top US Federal Reserve official urged the European Central Bank on Tuesday to consider employing a US-style quantitative easing program to counter slowing inflation and recession in the Euro Zone. The ECB has engaged in bond purchases in the past but has always withdrawn an equivalent amount of money from markets to ensure its interventions are neutral for the money supply, fearful of stoking inflationary pressures.

But with the ECB’s main interest rate now at 0.5% and Euro Zone inflation at 1.2%, St. Louis Federal Reserve Bank President James Bullard recommended the ECB could consider Quantitative Easing (QE), or printing money for asset purchases. “For the Euro area, which has not wanted to do QE, I would say this: If more monetary policy accommodation is desired, and it might be because inflation is running pretty low in the Euro area, the Governing Council on the ECB may want to consider a GDP-weighted quantitative easing program,” he said in a lecture at Frankfurt’s Goethe University.

With Euro Zone inflation undershooting the ECB’s target of just below 2%, the bank’s policymakers have discussed cutting the deposit rate they offer banks for holding their money overnight into negative territory from zero now. Bullard said that when debating this option in the United States, his concern had been that “There are not enough basis points to have that big of an impact, the other concern is that it would somehow impact market functioning.”

He expected a similar debate in Europe. Instead, he recommended the ECB pursue an asset purchase program. He expected this could be as effective as that employed by the Fed, which is currently purchasing US$ 85 billon worth of bonds every month. “For the Euro area, I think you might want to consider the GDP-weighted quantitative easing program’ Bullard said, summing up his presentation.

When asked whether he was on a mission from the Fed to convince the ECB of a policy change, he said: “If you know me, I’m always trying to convince people about my own views and sometimes I win, sometimes I don’t. But no, I speak for myself and certainly not for the Committee.” The ECB has mothballed its previous bond-buy plan, the Securities Markets Program (SMP), and has yet to activate its new plan the Outright Monetary Transactions (OMT) policy.

However, the mere creation of the OMT has helped narrow yield spreads in the Spanish and Italian bond markets which the ECB was thinking of when it created the program following its launch in September 2012. “If inflation slows further in Europe, the ECB governing council may wish to take actions beyond those, such as the OMT, that have been taken to mitigate the continent’s debt crisis,” Bullard said.

He also cited the Japan’s lost-decade of economic stagnation to reinforce his argument that just cutting interest rates was insufficient to ward off a damaging deflationary spiral. “Doing nothing risks the mildly deflationary situation experienced by Japan in recent years,” he said.