Too Little, Too Late for Eurozone

SMITH BRAIN TRUST -- Today’s vote by the European Central Bank to print more than 1 trillion euros for buying government bonds and other financial assets would have some benefits, but would not solve the region’s long-term challenges. That is the assessment of two experts from the Center for Financial Policy at the University of Maryland’s Robert H. Smith School of Business.

Phillip Swagel, a University of Maryland School of Public Policy professor and former International Monetary Fund and U.S. Treasury official, says the new round of quantitative easing — following the path taken by the U.S. Federal Reserve — would help Europe avoid deflation, but economic growth in the region would still be slow.

Bill Longbrake, executive-in-residence at the Center for Financial Policy, takes an even grimmer view. He says the proposed quantitative easing appears “too little, too late” for Europe, which is already in the early throes of deflation

Lessons from the United States

Swagel says the experience of the United States over three rounds of quantitative easing suggests that the tactic can support the Eurozone economies, but that European Central Bank action alone is not a salve for the ailing countries.

“The ECB can avoid deflation and thereby head off the worst outcome of a deflationary spiral,” Swagel says. “But interest rates are already quite low in Europe, and it is hard to imagine that even a large move such as a 100-basis point decrease in real interest rates (that is, nominal interest rates adjusted for inflation), would lead to a huge increase in investment and economic growth.”

He says this is the lesson from QE3 in the United States. “The incremental growth impact was modest,” he says. “But at least the ECB can avoid deflation — and that alone is a worthwhile goal.”

Strengthening Dollar

For the United States, Swagel says quantitative easing in Europe would likely mean an even stronger dollar that further disadvantages U.S. exporting firms against their European competitors. “But the bigger point is that an economically vibrant Europe is in the best interest of the United States,” he says. “We want Europe to succeed — and action by the ECB looks to be an important part of that right now.”

Momentum for Political Extremism

Longbrake, a former FDIC chief financial officer, says the quantitative easing would boost financial markets but not stem economic challenges helping fuel political extremism.

“Like Japan, Europe has fundamental economic problems and demographic challenges that lack effective solutions,” Longbrake says. “Unlike Japan, Europe has serious and intractable governance flaws. As a result nationalism has reemerged. Political fragility is escalating as economic difficulties erode the strength of centrist parties that have supported the European Project.”

He says momentum is building for more extreme political parties on the left and right, and eventually some will be in a position to assume power. That might come as soon as Sunday in Greece, if the Syriza party wins the election. “Even in long stable democracies, such as France and the United Kingdom, political fragmentation is gaining momentum,” Longbrake says. “This could become a serious matter in the U.K. as soon as May, when national parliamentary elections must be held.”