Quantitative easing (QE) is defined by Investopedia as “…an unconventional monetary policy in which a central bank purchases government securities or other securities from the market in order to lower interest rates and increase the money supply. Quantitative easing increases the money supply by flooding financial institutions with capital in an effort to promote increased lending and liquidity. Quantitative easing is considered when short-term interest rates are at or approaching zero, and does not involve the printing of new banknotes…” The Bank of England adds that this process aims directly to increase private sector spending in the economy and return inflation to target.
However, Central Banks do not (and under Article 104 of the Maastricht Treaty are not allowed to) purchase new government securities (ie gilts) directly from their governments. Such an action would, of course, provide EU governments with newly created money, which could be spent directly by government departments or used to reduce the national debt. This would be not unlike an overdraft with the central bank.
The text of the Maastricht Treaty Article 104 reads as follows:
1. Overdraft facilities or any other type of credit facility with the ECB or with the central
banks of the Member States (hereinafter referred to as “national central banks”) in
favour of Community institutions or bodies, central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of Member States shall be prohibited, as shall the purchase directly from them by the ECB or national central banks of debt instruments
2.Paragraph 1. shall not apply to publicly owned credit institutions which, in the context of the supply of reserves by central banks, shall be given the same treatment by national central banks and the ECB as private credit institutions.
This mandatory Maastricht rule makes sure that when an EU government expenditure exceeds its tax income, it is forced to borrow funds from the market and run up a deficit. This prevents it financing its overspend by printing money (or these days by creating electronic entries in its bank accounts).
Thus QE means buying government securities only on the secondary market. To do otherwise raises the spectre of hyperinflation (viz Zimbabwe or pre-war Germany).
Nevertheless QE still has its dangers. Sir Terry Leahy, the former boss of supermarket Tesco, has suggested that QE has “…created an awful lot of liquidity intended for the real economy, but found a home in markets and speculators looking for quick returns”. So this means that QE has generated asset price inflation, but not so much real GDP growth.
Therefore, there is a realistic argument for relaxing rule 104 in the case of longer term investments and productivity enhancing expenditure such as infrastructure, education and energy projects, which provide longer term benefit to society at large – in the UK perhaps supporting Cameron’s now less often quoted “big society”.
With so many people across the EU suffering from austerity measures, directing QE towards genuine GDP enhancements instead of fuelling asset price inflation, as Leahy has pointed out, must surely be worthy of action at the European level. Providing a mechanism to generate new money for these projects without cost, must be worthy of hard debate.
With the UK facing an in-out referendum and Cameron attempting to re-negotiate the EU’s mandate, now is surely the time for our politicians to exert some creative influence and relax rule 104.
- Investopedia - QE definition
- Bank of England - QE definition
- The Independent - QE explained
- FT - QE definition
- The Guardian - printing money to fund green investments
- Finance for the future - Green QE
- This is Money - What is quantitative easing and does it work?
- The Guardian - Corbyn's QE for the people
- OMFIF - Wider QE woud contravene Maastricht