Paul Sheard has a clear view of what the European Central Bank should be doing, and it’s not the same as Germany’s. The chief economist of the global rating agency Standard and Poor’s warns that anyone saying the ECB’s €1.14 trillion, or $1.21 trillion, bond-buying program isn’t working, or should be stopped earlier, was probably against it from the beginning. In an exclusive interview, he urges markets and economists to give the ECB’s policies time to work.
Growth in the Eurozone economy has picked up recently. How much is that due to the ECB’s decision to launch quantitative easing, or QE?
I think it is definitely an important factor. The QE-decision is the culmination of a series of quite radical steps by the ECB, starting with the introduction of negative deposit rates. This regime shift in monetary policy already started in June 2014. So there is a positive influence on growth in the euro zone. We have just upgraded our growth forecasts for 2015 and 2016.
But isn’t this improved growth mainly due to the low oil prices?
The oil price plays a role. But QE has already contributed to higher confidence and to the weaker exchange rate, lower interest rates and higher equity prices. The financial market response has been quite quick, but the ultimate response of the economy will take time.
With its monetary policy, the ECB has changed the incentives in the economy. But it will take time for companies and households to react to that. There is already an effect, but it will become stronger over time.
The markets reacted quite strongly when the ECB launched its bond-buying program in March. Were you surprised by that?
No. Of course the markets had already reacted before, but as I said, QE was part of a regime shift by the ECB. Before the purchases began, there was still uncertainty about whether the ECB would make this move and how they would do it.
Has everything now been priced in? Or will the bond purchases still have an effect on markets?
Markets have digested the first response. But there are still uncertainties about how successful the measures will be. If the economy does not react, there could be a discussion about another round of QE.
Some economists are already demanding a reduction in the purchases. Does the ECB already need an exit strategy?
No, it’s far too premature to talk about the exit. I think this claim comes from people who were anyway opposed to QE. They have changed their argument from ‘the ECB should not do QE’ to ‘they should exit as quickly as possible.’ If you accept QE as a desirable policy, then the ECB should see it through. QE has to be determined and decisive. The way the ECB has designed this is close to be best in class.
What do you mean by that?
It is open-ended and it is clearly bound to the target of getting inflation up to around 2 percent. This is very similar to what the Bank of Japan is doing and to what the Fed did under QE III. It took the Fed about four years of institutional learning to get to this way of doing QE. The Bank of Japan started to experiment with QE in 2001. But it was not until March 2013 that it adopted this way of doing QE.
The ECB is buying bonds according to its capital key. That means it is primarily buying German bonds, although yields are already in negative territory for maturities of up to seven years. Does that really make sense?
From an economic point of view, this is not the most efficient way of doing it. It would be better to tie the bond purchases to the outstanding amount of bonds, or to the level of interest rates in certain countries. But the euro zone is not a nation state, so the ECB has to consider its legal constraints. Under this condition, and given the controversial nature of the move, this was probably the best way for the ECB to start its QE program.
Jan Mallien, who covers monetary policy for Handelsblatt in Frankfurt, conducted this interview. To contact him: email@example.com