Andrew Watt

Francesco Papadia, a distinguished monetary policy expert, has written an unfortunately potentially misleading piece on quantitative easing (QE) by the ECB. Entitled Some unpleasant Quantitative Easing Arithmetic, the author argues, in essence, that “arithmetics” militate against the use of QE because of the following three facts: the sums needed are large, the only asset classes that are of commensurate size are sovereign bonds and bank loans, and “ECB seems to dislike the purchase of sovereign bonds and it is really difficult to envisage, for all sort of reasons, purchases of trillions of bank loans”.

Well, imagine someone who, in their normal, comfortable, advanced-country life, is a strict vegetarian. They have a balanced diet and all is well. Suddenly, however, they find themself on a New Zealand-like desert island which consists of grass and sheep. For a week the poor unfortunate munches grass and gets weaker and weaker. As a commentator would you a) complain about the cruel and unpleasant arithmetics of this situation or b) suggest that the person should urgently consider revising a lifestyle choice that, while it might have made sense in normal times, is completely inappropriate, indeed mortally dangerous, under the prevailing circumstances?

I will defer to Mr. Papadia regarding the technical difficulties involved in buying large quanitites of bank loans, but it is surely obvious that the crux of the supposedly unpleasant arithmetic problem lies in the “lifestyle choice” of the ECB not to buy large quantities of sovereign bonds. This may make sense in normal times. But the simple fact is that, faced with similar problems (virtually zero interest rates, high unemployment, worryingly low inflation) the other leading central banks of the world have all adopted very substantial bond-buying programmes. The ECB has not. (Extend the metaphor: there are four people stranded on the island. After a while three have started eating mutton. One is sticking to grass and wonders why he is weaker than the others.) This is very clearly a political choice, and to imply that there is an arithmetic problem linked to the relative size of certain asset markets, as the author, perhaps unwittingly, has done, is very unfortunate in the current context.

There is an additional point which is that the author takes as his starting point the accumulated size of asset purchases by the other central banks (of the order of a quarter of one year’s GDP) to emphasise the huge scale of needed purchases. But QE is a scalable policy. Smaller packages would be helpful. And more fundamentally, the ECB has to start somewhere and sometime. It does not have to decide tomorrow what assets worth a quarter of annual GDP it has to buy in one fell swoop. Start with the easy ones (a sheep that has died of natural causes and does not need to be killed in order to provide sustenance).

To sum up, while this may not have been the author’s intention, the article risks serving as a justification for – or at least woefully fails to challenge – the ECB’s continued monetary policy foot-dragging that is taking unnecessary and potentially disastrous risks with the euro area economy for eminently political-ideological reasons that have little to do with arithmetic.