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QE is not, should not and cannot be a substitute for structural reform - IoD

23 Jan 2016

Commenting ahead of the expected ECB decision to launch a programme of quantitative easing (QE) across the Eurozone, James Sproule, the IoD’s chief economist said:

“The IoD is sceptical about the European Central Bank’s proposed quantitative easing programme. If QE is used simply to support government deficit spending through the purchase of sovereign bonds, it may provide a short term Keynesian boost but it also allows politicians, once again, to avoid tough decisions. Ultimately, QE on its own risks setting the Eurozone on the road to Japanese-style stagnation and deflation. QE is not, should not and cannot be seen as a substitute for the kind of structural reforms to labour and product markets that the EU so desperately needs.

“The problem across much of the Eurozone is a lack of entrepreneurialism, as rigid and anti-competitive systems hold back enterprise and growth. Much greater liberalisation of product markets is necessary and we must appreciate and accept that the disruption this causes will lead to a degree of creative destruction. High European unemployment remains a structural issue, and businesses are unwilling to hire because of a desire to avoid the significant liabilities of employment that still characterises Eurozone labour markets. No program of QE is going to address these issues, although the healthier the general economy the more rapidly these necessary changes can be enacted.

“When it comes to QE, it is important to understand the difference between the Eurozone and the United States and, to a lesser extent the United Kingdom. Simply put, QE in the Eurozone will be a different beast because the underlying structures of Eurozone businesses and finance arrangements are distinct from the British and American models.

“The German insistence that European central banks make only secondary bond purchases will ensure that Eurozone QE will be different from that in the US and UK. Eurozone QE is going to be a non-risk sharing model, which underscores the incomplete nature of Eurozone economic and monetary union.

“Equally critical are the structural differences in business financing. European businesses are far more dependent on bank debt than their American counterparts. In order for Eurozone QE to work, European banks have to use the new cash to lend, which in turn means they must be confident that their existing balance sheet is solvent and that the new loans they make are equally prudent. While recent stress tests may have given the ECB some comfort with regard to the solvency of European banks, doubts remain in the financial markets. Moreover, with bankers having just weathered a near decade-long storm, there is an understandable degree of caution. This caution seems well justified when looking at the poor macro-economic outlook for much of the Eurozone and undermines the potential for new business lending.

“The European Union needs reform, and in the UK business support for the EU is predicated on such reform taking place. Member states need to work quickly to liberalise social and employment law, complete the single market in services and embrace digital innovation. The risk now is that QE blunts the desperate need for wider economic reforms.”

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