QE the European way
“And that’s the wavering commons: for their love lies in their purses, and whoso empties them by so much fills their hearts with deadly hate.” The great English poet William Shakespeare hit the nail on the head. Four centuries after his death we can use his words to explain how people in Korea felt when they filled out their forms for their income tax refunds in January. Many will fail to get refunds this year. Some will have to cough up more than was deducted from their salaries. And their hearts are filled with resentment toward the government for tweaking the tax codes and demanding more that what they took a year ago.
In contrast, European authorities are out to fill the purses of the European masses. The European Central Bank decided on Jan. 22 to embark on a massive quantitative easing program - a 60 billion euro ($68 billion) bond-purchasing program each month from March until the end of 2016. The bank will purchase 1.14 trillion euros worth of bonds from 19 eurozone countries and pump that much money into the member economies. ECB President Mario Draghi, who has earned the nickname Super Mario for his unconventional and bold ways, has lived up to his reputation. The move sent stock prices in the region skyrocketing and the euro’s value fell to an 11-year low, raising hopes for rejuvenated exports and corporate investment.
The European Central Bank resorted to the unconventional monetary stunt already employed in the United States, Britain and Japan, amid imminent signs of deflation and prolonged slump. The euro bloc is expected to grow 1.2 percent this year after 0.8 percent growth last year. Unemployment in crisis-hit countries like Greece and Spain is above 25 percent. Prices in the region fell 0.2 percent from the previous year in December.
When prices fall, both the private and public debt burden increases. Government liabilities of euro members on average are tantamount to 96 percent of total gross domestic product. That ratio is 175 percent for Greece. Deflation worsens the financial squeeze on families with debt and dampens consumer spending. Higher borrowing costs also hurt corporate investment. As can be learned from Japan’s decades-old stagnation, deflation is accompanied by a lengthy slowdown. Central banks have to keep interest rates at low levels and pump in liquidity in order to artificially spark inflationary pressure.
The European bank cannot send interest rates lower as the policy rate is already 0.05 percent. It had to turn to the last resort of printing money and buying bonds for increased liquidity in the hope of sending consumer price rises to 2 percent and revive the economy. Since the purpose of quantitative easing is clear - to combat deflation at an early stage - and the scale has been beyond market expectations, the action could be successful. The central bank cannot fix the structural problems of the troubled southern member countries with low productivity and high debt levels. Germany worries that quantitative easing will only delay economic reforms and push debt problems onto the rest of the continent. Members reached a compromise to have state central banks shoulder the losses on their purchased bonds and exclude Greek government bonds from the program. It was the best possible deal considering various complications in the eurozone.
The Bank of Korea on Jan. 15 estimated this year’s growth at 3.4 percent and inflation at 1.9 percent. Growth is estimated at 3.0 percent and inflation 1.2 percent in the first half. The bank is hoping that the economy will do better in the second half. If the government skillfully works with macroeconomic policies, the economy could beat the low growth and inflation estimates. The economy still has the potential to do better. Its average growth was 4.2 percent from 2001 to 2010. Then the problem of Korea’s aging society began to kick in, hurting corporate investment and productivity. Our growth potential has been pared back. Last year’s data showed a lack of jobs and low consumer prices, but a large current-account surplus suggests that the economy is underperforming its potential. In a recent study, the Asian Development Bank said that with an adequate policy mix, reforms and innovations, Korea has the potential to grow at 4.5 percent a year.
This year’s inflation estimate is below the target stipulated in the Bank of Korea law. The stable price target through 2013 and 2015 was set in the range of 2.5 percent and 3.5 percent. Inflation has been hovering below the target since June 2012. It was at 1.3 percent last year. We are still safe from the danger of deflation. Still, the Bank of Korea should change its policy if its conventional monetary posture is keeping the prices too low. Higher growth and inflation could increase jobs and incomes.
That would also boost tax revenues for the government and give it leeway to push ahead with welfare programs. The European bank’s quantitative easing was bold, preemptive and beyond expectations. We hope that the Korean government and central bank will be as surprising - and satisfy us with policies that will fill our purses.
Translation by the Korea JoongAng Daily staff.
JoongAng Ilbo, Jan. 30, page 31
*The author is professor of economics at Korea University.
by Lee Jong-wha