Europe's last weapon

Despite ECB’s recent rate cut, the Euro remains as strong as ever. It’s easy to imagine Mario Draghi pulling his hair out: just what does one need to do to force its currency lower and boost Europe’s peripheral economies, especially in a world where every other major central bank seems to be running the printing press at full tilt?
Sadly, the answer might be, to join them in the global exercise of quantitative easing. The favourite analogy I use to explain QE to my grandma goes like this: it’s sort of like persuading a massively obese man to do some exercise and walk to work by offering to buy his car for a price that he simply can not refuse. Despite the fact that many see QE as the very embodiment of evil, it’s still better than doing nothing, and that “nothing” seems to be an accurate description of the other politically-acceptable alternatives.

Europe ’s macro indicators have looked rather grim lately. One figure sums up the parlous state of affairs: the eurozone inflation at 0.7% is currently lower than that of Japan (1.1%). If it goes any lower, and as rates are already close to the zero bound, getting inflation back up again could be extremely difficult. In fact, it may be impossible. You can’t wait till you are caught in a storm to think about purchasing an umbrella.
Also, some economies in the eurozone are already in deflation. Would you buy something today if it were cheaper tomorrow? Countries that are undergoing structural reforms may well need negative real interest rates. Extremely low inflation militates against structural reforms.

What ammunitions does the ECB have left then? Rates can go lower but there is barely any room left. I can’t quite imagine negative deposit rates in a major currency. Of course the Swiss embraced this a long time ago, but somehow I feel that all things Swiss can effectively be confined to a little box that works in a parallel financial universe with zero gravity where expensive mechanical watches and mountain shaped chocolate bars operate in their own airport duty-free shop of Lalaland.

That leaves us with QE or something that subtly resembles it such as OMT and LTRO. My earlier comparison of QE to overpaying a fat man for his car is a little mean but fair. QE works by reducing the returns on assets like bonds to the point where other activities become interesting to investors. This is definitely a rather roundabout way of driving money into the real economy but it might just work.
It will not be easy politically by any means: open splits on national lines will emerge and Bundesbank will have an enormous fit. It might be unsuitable for Germany and might cause asset bubbles. But this is true in exactly the same way that the monetary policy pursued before the crisis was ill-suited for Spain and did indeed create a property bubble on those beautiful Spanish beaches. Any central bank tasked with the job of delivering a target rate of inflation in an union of vastly diverse economies will destabilise some of its members at any given point in time. This is akin to complaining that “each carriage of this train has its own engine and conductor!”. It’s a description of the whole damn point of a currency union.

I don't mean to imply that using the printing press is an intelligent choice for the ECB, nor is it a solution. Nevertheless, absent a revolutionary political change, it’s Europe’s last weapon. We can lament the political deadlock that has left Europe with a partially zombified financial system. But given a choice between zombies with and without QE, evidence probably support the former.