Printing Money to Save an Economy? Understanding the ECB

Europe is struggling, and the European Central Bank (ECB) thinks it can help.

Several years after the financial crisis, the European economy is still reeling. European countries are holding massive amounts of debt— Italy, Spain and Greece are among the countries whose debt is greater than their Gross Domestic Product, or their total production as a country. Debt isn’t always bad, but over time it can constrain an economy, just like personal debt will eventually come back to haunt a careless borrower.

Worse still, economists worry that the Euro—the universal currency used in 19 European countries—is deflating. In the financial world, this means that debt gets harder to pay off, because while each euro might be getting more valuable, borrowers still owe the same amount, which means they pay more in terms of “real” value. For the everyday European, this means more financial strain, more unemployment, and more uncertainty.

The Response

On Thursday, the ECB finally responded to Europe’s economic woes by announcing that they would begin a policy called quantitative easing (QE). The mechanics of this policy are anything but simple. If a central bank wants to engage in quantitative easing, it will “create” new money and use it to buy up financial assets and governmental bonds.

This is meant to do two things. First, doing so increases the money supply, either slightly inflating a currency or keeping the currency from deflating. Second, it lowers general interest rates, making it easier for people to borrow money, encouraging them to invest. So, even if people’s money is worth slightly less, more people are spending, and growth is (hopefully) spurred forward.

QE isn’t new. In 2000, the Bank of Japan tried to implement the policy to combat the country’s slow growth. As Japan didn’t seem to improve, many economists saw this as a failure. Even still, in 2008 the Bank of England and the Federal Reserve (the U.S. central bank, known as “the Fed”) both enacted their own separate QE policies. In fact, the Fed went through three different cycles of quantitative easing, ending only in October of last year. Whether these central bank policies have worked is still up for debate.

After this week, the ECB’s position is clear. The bank is going to create 60 billion euros monthly, that’s $70 billion in U.S. dollars, to buy up assets for at least the next 19 months. By the end, over a trillion new euros will flood the European economy.

What Could Go Wrong?

There are at least two reasons to be skeptical of the ECB’s move.

First, we have to wonder whether QE has worked in the past. Japan’s economy doesn’t seem to have improved. And, while the U.S. economy looks a bit better, it’s hard to pinpoint the exact reason—in other words, the economy may have improved despite QE, as opposed to because of it.

Second, the ECB’s move might just be too little, too late. The European economy has suffered for a long time, and often the problem has been caused by states like Greece, which have done a terrible job of keeping their erratic spending in check.

Economies, however, need confidence—and that might be the biggest reason the ECB decided to do what it did. When the authorities do nothing, people often feel as though they’re caught in an inevitable slide. In this case, Europeans are worried about a “triple dip” recession, a third slump after the initial fall.

If the ECB’s move can increase confidence, the resulting economic activity might be enough to inspire some growth. Until then, all eyes are on Europe.