The good news started with the German Constitutional Court ratifying the euro-zone bailout package under the European Stability Mechanism (ESM). This was followed by the US Federal Reserve introducing its third quantitative easing (QE) programme.
For euro-zone economies, the German government can now contribute its 27.1 per cent share (190 billion euros) into the 700 billion-euro bailout fund, which was set up to buy debt issued by highly indebted governments (mostly PIIGS economies), as they can no longer borrow on their own credit-standing. As the first paid-up capital tranche, Germany will have to contribute 21.7 billion euros out of the total paid-up capital worth 80 billion euros.
However, there are conditions attached by the German Constitutional Court. Firstly, both German houses of parliament must be informed, if the ESM require additional funding. Secondly, Germany must place a cap on any potential contributions when ratifying the treaty. The cap must not exceed 190 billion euros. This is a significant restriction, as the size of proposed bailouts has ballooned at every turn since the beginning of the crisis. The third provision is that Germany may raise its share of the ESM in future, subject to the consent of both houses.
In any case, I think the court decision may already be redundant, as there has already been the European Central Bank (ECB) announcement of the unlimited open market operation programme, which has already supplanted the ESM as the euro zone’s medicine of choice. The ESM will only be called upon if open market operation fails completely in its mission to drive down the yields on traded debt.
The second piece of good news for the world economy is the US Federal Reserve’s decision to unleash another economic stimulus measure, its third attempt at a controversial programme to rev up the US economy. The policy, known as quantitative easing (QE3), entails buying US$40 billion in mortgage-backed securities each month. The end date remains up in the air, as the Fed will re-evaluate the strength of the economy in the coming months.
The Fed is wasting no time, as the purchases began the day after the announcement was made. The official Fed statement mentioned that the bond-buying policy “should put downward pressure on longer-term interest rates, support mortgage markets and help to make broader financial conditions more accommodative”.
Meanwhile, the Fed will continue its existing policy, known as “Operation Twist”. Together the two programmes will add $85 billion in long-term bonds to the Fed’s balance sheet each month. In addition, the Fed also indicated that it plans to keep short-term interest rates at “exceptionally low levels” until mid-2015.
Previously, the Fed had forecast interest rates would remain low until late 2014. Obviously, the central bank’s main objective is to lower interest rates and mortgage rates in particular. By keeping rates low, the Fed hopes to fuel more spending and eventually more hiring and employment.
The main problem with the US economy now is the high unemployment rate, at above 8 per cent. We can see that the Fed is concerned with the employment situation: in its statement, it indicated that it will not only continue QE3, but also “employ its other policy tools” if the “labour market does not improve substantially”.
Notwithstanding the good news of monetary easing by the US Fed, there is still fierce criticism of QE. Last month, the Bank of England (BOE) issued a report that must have made Fed chairman Ben Bernanke squirm. It said that the Bank of England’s policies of quantitative easing – similar to the Fed’s – had benefited mainly the wealthy. Specifically, it said that its QE programme had boosted the value of stocks and bonds by 26 per cent, or about $970 billion.
The BOE report said about 40 per cent of those gains went to the richest 5 per cent of British households, but the BOE countered that the benefits of easing may have trickled down, and that without the BOE’s asset purchases, most people in the UK would have been worse off. This has sparked growing controversy about how Fed policy has mainly helped the wealthiest Americans. Many economists now think QE is fundamentally a regressive redistribution programme that boosts wealth for those already engaged in the financial sector, or those who already own homes, but passing little along to the rest of the economy.
I may be a pessimist on this issue because I expect the benefits from these recent developments to be minor, while the global economy still faces risks and uncertainty. Although the first two rounds of quantitative easing lowered interest rates and fuelled stock market gains, banks have still not been eager to lend out money readily, as they are sitting on $1.6 trillion in reserves and credit conditions remain tight. Households continue to pay down debt, and are in no hurry to ramp up their spending.
The US economy may now be in what we call a “liquidity trap”, while euro-zone economies still have yet to reach consensus agreement on the only way forward – establishing a full-fledged fiscal union. Somehow I do not think we are out of the woods yet.
Dr Chodechai Suwanaporn is executive vice president, economics & energy policy, PTT Public Company Limited. Chodechai.firstname.lastname@example.org.