It is not quite certain yet whether the ECB will announce a concrete sweeping government bond purchase program this week. However, at the latest by the time of the next meeting in early March, a majority of the Council members are likely to have reached agreement on the terms and conditions. We still consider large-scale QE, and the massive increase in the balance sheet that the ECB is aiming for, to be inappropriate. After all, the drop in oil prices has only temporarily pushed eurozone inflation rates into negative territory and it is a boon for economic growth. The slide in the value of the euro is also having a positive impact on the economy and prices. The depreciation of the euro seen so far is therefore welcome. However, if further drastic monetary policy measures are taken, there is a mounting risk that the exchange rate movements will overshoot.
As far as the possible terms and conditions of the government bond purchase program are concerned, it is worth bearing in mind that German yields, in particular, are already extremely low, making any impact that QE could have on growth or inflation correspondingly small – apart from the fact that this strategy runs the risk of substantial side effects for the financial markets. Looked at from this angle, it would seem a good idea to let national Eurosystem central banks buy government bonds for their own account/at their own risk, leaving it up to the Bundesbank to decide whether or not it wants to take part. This sort of approach would also take the edge off the problem of joint liability, because each individual country – or rather, its taxpayers – would then be liable for the investments made by its own central bank. There is, however, a big question mark hanging over what would happen if the worst came to the worst, i.e. if the bonds purchased became junk bonds and national governments were unable to cover the losses sustained by their central banks. This would probably trigger some sort of joint liability after all. This is not the only reason why national government bond purchases are only acceptable subject to stringent monitoring and only up to set maximum limits in relation to government debt. With national government bond purchases, it is important to coordinate and manage the impact on the money supply, in particular. It is also important to keep an eye on the extent to which bank refinancing via the sale of government bonds to their central bank serves to push the Target II balances within the monetary union, which are down on the crisis level of 2012 but are still sitting at a high level, back up. Target II balances reflect a malfunctioning market and, when it comes to the crunch, also imply a redistribution of risks between member states (or central banks) with surpluses and deficits.
A large-scale QE program is looking far more likely in the wake of the opinion published by the ECJ Advocate General on the OMT program last week. It has backed the ECB by giving it broad discretion (and at the same time depriving the courts of competence regarding the details). The ECJ Advocate General also stressed, however, that the ECB has to clearly explain its actions – in the interests of accountability. In terms of large-scale government bond purchases as a form of quantitative easing, this means that clear boundaries have to be drawn to delineate state financing and that the measures should be linked to inflation development. The latter, however, is not straightforward in practice, because the ECB would have to tie the duration and scope of its QE measures to expected, as opposed to current, inflation.
We expect that the ECB will not "disappoint" the markets in terms of the extent of the government bond purchases, as it was the ECB itself that fueled market expectations by expressing its "intention" to expand its balance sheet to EUR 3 trillion. Hope nevertheless remains that the ECB will retain the necessary degree of flexibility in the structure of the purchase program so that it can make a timely exit if necessary. In this respect, monthly targets for purchase volumes that can be reduced or suspended entirely if need be would certainly make more sense than setting out an overall target of around EUR 500 billion.