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Why The ECB Got To Do What It’s Got To Do

September 16th, 2012 · No Comments

Why ECB action was unavoidable
Editors Pick at Seeking Alpha:

Why The ECB Got To Do What It’s Got To Do

September 2, 2012  | 29 comments  |  includes: EWP, FXE, GGOV   

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…)

We have long held the belief that unlike other parts of the world, quantitative easing (QE) could actually accomplish a lot in the eurozone.

QE is central banks purchasing long dated assets like public bonds. Buying shorter assets is considered part of normal open market operations to establish target interest rates and liquidity to the banking system. When short-term interest rates are effectively zero and the economy is still producing way below capacity, QE can be considered as an additional tool.

This is what the Bank of England (BOE) and the Fed have done in the wake of the financial crisis, and it is what the Bank of Japan has done for six years in the last decade. The economic conditions under which this instrument was applied were quite similar in each of these cases. A credit-infused asset bubble imploded, leaving ravishing balance sheets of households, banks and/or firms.

In order to restore balance sheets, spending, borrowing and lending goes down, creating a savings glut and an output gap (the economy producing way below capacity), rising unemployment and falling asset prices. This Fisherian debt-deflationary process can easily feed on itself, hence the need for rather strong policy action. If not, the economy can easily slump into a 1930s style depression. [Read on here]

Tags: Sovereign debt crisis