It’s a well-known fact that since the financial crisis the Fed and the ECB have pursued rather different monetary policies: the Fed has engaged in large amounts of quantitative easing (QE) –purchases of mortgage-backed securities and other securities such as government bonds –, while the ECB has relied on more conventional monetary policies (the lowering of interest rates and long-term refinancing operations).
Many experts attribute the fact that the US has recovered much better, in economic terms, than the eurozone (EMU) to the more expansionary monetary policy pursued by the Fed, and argue that the time has come for the ECB to engage in QE as well. But this is a gross simplification. There’s growing evidence that QE has had almost no effect on the real economy and economic recovery: loans to American businesses and households are still well below pre-crisis levels, despite the massive increase in base money (central bank reserves). This is because QE – or better, the idea that QE is the optimal tool to revive an economy in recession – is based on a fallacious view of how monetary system works.
The monetarist or quantitative theory of money – which took hold in the 1980s and is still dominant in most central banks – asserts that banks need excess reserves before they can loan out deposits (according to the so-called ‘money multiplier’) and thus that central banks can directly, or exogenously, control the money supply by influencing the reserve requirements of banks or by increasing reserves through QE (even more so, supposedly, if such reserves are obtained by offloading toxic assets from the banks’ books). The economic corollary to this theory is the so-called ‘wealth effect’, a variation on the classic (and blatantly disproven) ‘trickle-down theory’. This is the belief that virtuous economic cycles don’t begin with increased demand but rather with increased equity prices, with rising asset prices leading to beneficial effects in consumer sentiment, retail spending, along with corporate capital expenditure and hiring.