Europe is in trouble and the problem (one of them) is deflation. From December 2013 to December 2014 the inflation was -0,2%. ECB`s goal is like the FED`s; about 2%. The European Central Bank announced today that it will fight against deflation and recession by «printing more money».
Many people don`t know that the Central Banks are not printing money like they use to think; printing paper money. But others say «printing money» to make ordinary people understand what they are talking about.
Central banks have a tool to control growth and that is lowering or raising the interest rate. When the interest rate is low, people will spend more money which is good for the economy. Spending is also better than saving.
When interest rate is as low as it right now, the central banks need to do something. The tools they use is to «print more money», and that is quantitative easing QE. But does it help the economy? According to Obama in a speech yesterday; it does.
The banks use this money to buy bonds from investors such as pension funds and private investors that will use this «new» money. This again will increase the amount of money in the financial system, which is encouraging financial institutions to lend more to businesses and individuals. The goal is to allow them to invest and spend more and that will hopefully increase the growth.
QE makes the prices of government bonds to go up and reduces the yield paid out to investors, which means investors have to pay more to get the same income. This is why some pension scheme deficits have increased sharply in resent years.
It is Greek elections on Sunday, and ECB bond-buying could support confidence in troubled Euro zone members and prevent any fallout from Greek politics affecting other countries. Some said the Greeks are poised to reject the EU-imposed cost-cutting and vote for Syriza, which rejects the fiscal crackdown. The ECB will buy bonds from Italy and Germany and that will prevent them from selling their bonds if the economic situation in Greece worsens. Draghi said today that they can continue to print money the next 30 years. No one knows that this program will work.
QE was first used by the Bank of Japan (BOJ) to fight domestic deflation. BOJ had for many years claimed that QE is not effective and rejected its use for monetary policy. BOJ hade maintained short-term interest rates at close to zero since 1999.
During their QE, the BOJ flooded commercial banks with excess liquidity to promote private lending, leaving them with large stocks of excess reserves and therefore little risk of a liquidity shortage. The BOJ accomplished this by buying more government bonds than would be required to set the interest rate to zero. It later also bought asset-backet securities and equities and extended the terms of its commercial paper-purchasing operation.
Since the financial crises of 2007-2008, similar policies have been used by the United States, the United Kingdom and the Euro zone. QE was used by these countries because their risk-free short-term nominal interest rate were either at or close to zero.
ECB will start their € 1,1 trillion QE program in march. They will start buying 60bn euros of chiefly government debt each month. That includes rebundled private debt, asset-backet (public and privaate) securities and covered bonds worth about 10 billion euros on top of the roughly 50 billion euros in state bonds.
They will spend (as they signalled in 2009) € 60bn euroes each month until September next year. The Euro dropped down to an 11 year low against the strong dollar. The pair is now trading at $1,14.
Mario Draghi has delivered a bigger bazooka than investors were expecting, and the stock market in Europe, Asia and U.S skyrocketed today. Bull!
By the way; Denmark`s Central Bank followed the ECB today by cutting its main deposit rate again. This time to negative -0,35%. They had already lowered that rate to negative -0,2% from negative -0,05% on Monday this week.
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