Technical Changes to QE Under Review
As the Federal Reserve gears up for a second interest-rate hike, its sister organization across the Atlantic Ocean is also considering some important changes. The European Central Bank (ECB) recently indicated a willingness to review its asset purchase program.
All of these proposals are ways for the ECB to leave room for extending its bond purchase program. It officially began in March 2015 and was extended earlier this year, both in timeline and budget. The monthly purchases jumped from €66.0 billion to €80.0 billion.
According to Thomson Reuters, these changes could allow the ECB to skirt a rule that forces all bond purchases to be made in proportion to the size of constituent economies. (Source: “Exclusive: ECB may review QE options but decision could be put off until December,” Reuters, October 12, 2016.)
For instance, under existing rules, the ECB would have to buy 31 times more bonds from Italy than from Luxembourg. Why? Simple: the Italian economy is worth $1.8 trillion while the output of Luxembourg only adds up to roughly $57.8 billion.
But if Luxembourg were entering a period of acute economic distress, it might need an outsize amount of help. Some analysts speculate the rule change is intended to lower the amount of stimulus currently directed towards German bonds.
The German economy is the largest and most secure of the eurozone nations, meaning that it often requires the least aid, yet it receives the most. This technical review would free up the ECB to triage according to the severity of economic distress.
However, it would also support German complaints that Germany carries water for the weakest eurozone countries. They argue that easing the proportionality rule would create a subsidy system whereby Germany hands money to irresponsible nations in the currency bloc.
But the ECB may not have any other choice. By many accounts, they are simply running out of German bonds to buy, so diverting that cash may be a necessity. Other proposals include letting the ECB buy bonds that yield less than the deposit rate, or granting them the freedom to buy a bigger share of each bond issue.