And if the Germans are pulling their hair, investors have reason to rejoice. For example, in October, the ECB has resorted to a form of quantitative easing, a policy used by the Fed, the Bank of England and the Bank of Japan to stimulate their economies – this strategy has failed in Japan, but gave positive results in the United States and the United Kingdom.
When a central bank uses quantitative easing, it buys financial assets (government securities and private sector assets) financed by the expansion of its reserves. This increases the price of these assets and decrease performance.
As a result, the increase in reserves of the central bank made available to commercial banks leads them to increase the supply of credit to businesses and individuals. This is what allows to revive economic activity.
The Fed is a model to follow, according to Ben Bernanke
In October, the ECB has launched a program of asset-backed debt securities purchase (Asset-Backed Securities), which originated from other financial institutions and SMEs.
But his strategy is far weaker than that deployed by the Fed and the Bank of England, which have pumped billions of dollars into the financial system, including purchasing government securities.
This is what explains why the Americans and the British managed to revive their economies, while the euro zone did not succeed, according to former Fed chairman, Ben Bernanke.
“The United States and the United Kingdom have used quantitative easing, and they managed to revive their economies. Continental Europe has not done so, and failed to revive its economy,” said he was in a speech to the Montreal CFA Society on 19 November.
According to many analysts, the new approach of the ECB, however, is auspicious because it is more likely to stimulate business investment and job creation in the euro area by sole reduction of rate interest.
The victory of Mario Draghi over the German orthodoxy
The ECB owes its new strategy to its president, Mario Draghi. He managed to convince the Board of Governors of the European Central Bank (composed of six members of the Executive Board of the ECB and the governors of the national central banks of the 18 countries in the euro area) based in Frankfurt, Germany, to go this direction.
The Germans were not warming up to the idea of using quantitative easing, but their influence decreases with the gradual enlargement of the euro area – it also will include a 19th member country, Lithuania, from 1 January 2015.
Germans tend to favor fiscal austerity and reforms to revive the economy of the euro area. Their major concern is that countries like France and Italy implement the reforms needed if the ECB intervenes more to stimulate investment and job creation.
However, to date, the German approach has had little impact in the euro area, say most economists. The three pillars of the euro area – Germany, France and Italy – are in trouble, not to mention the risk of increasingly large and disturbing Japanese-style deflation.
This is why quantitative easing is probably the best card that Mario Draghi can now play, say analysts.
On Friday, the head of the ECB even indicated that he would adopt new monetary easing plan to boost inflation. The plan would consist in measures that could include massive purchases of sovereign bonds from countries in the euro area. This would be a new twist to the German monetary orthodoxy. And new hope for investors.