ECB and the Limits of QE

Markets were clearly underwhelmed by the European Central Bank’s (ECB) easing announcement yesterday, marginally cutting its (already negative) deposit rate and extending the duration of its asset purchase program (QE). I think the Financial Times had it about right. It would have been better to do more, but what they did was helpful and it retains the capacity for further action. Still, as Ted Liu and I argued yesterday, the main channel through which QE is going to boost activity in Europe (as the Federal Reserve normalizes) is through the exchange rate, which in the context of weak global demand and emerging market capital outflows may be a modest source of stimulus. The market reaction also underscores the challenge for a central bank to communicate its intentions when the governing council is divided and it is trying to be data dependent--i.e., it is hard to communicate what you don’t know. We also agree with the FT’s bottom line: at this time, monetary policy alone cannot be expected to carry forward a robust European recovery.  Fiscal and structural policies must do their part.