One year after the start of its quantitative easing programme (QE), the ECB has decided to extend it based, among other reasons, on the fact that QE is fulfilling its task of stimulating the economy. In previous Focus articles we have seen how the programme's implementation has gone as the ECB planned.1 We will now analyse the macroeconomic impact of the programme to answer the following questions: does QE work and does it need to be extended?
The most immediate effect of the announcement and implementation of QE as from the first quarter of 2015 has been downward pressure on interest rates. This has reduced the cost of credit for companies and households and has depreciated the euro against the euro area's main trading partners. QE therefore stimulates the economy both by boosting domestic demand and also by making European exports more competitive in the rest of the world.
To quantify the macroeconomic effect of QE we exploited the historical relations between the rate of growth in GDP and the ECB's benchmark interest rate to calculate the impact of monetary accommodation.2 As can be seen in the graph, according to our calculations a 25 bps drop in the interest rate produces a gradual increase in the GDP growth rate up to a maximum of around 13.75 additional bps after about two years. How can we extrapolate this figure to estimate the repercussion of QE? After the ECB's meeting on 3 December 2015, Mario Draghi revealed that the results achieved with QE were equivalent to what would have been produced by cutting the Refi rate by 100 bps. Extrapolating the estimated figures, our calculations indicate that QE may add 55 bps to the year-on-year growth rate in GDP at the end of 2017 (the cumulative effect would place GDP 1% higher). However, although the effect of QE on the economy may be equivalent to a reduction in the Refi rate of 100 bps, the measures used to achieve this impact have gone much further. As we saw in a previous Focus,3 the so-called «shadow interest rate» summarises the unconventional measures in an interest rate equivalent to the Refi rate. In fact, it suggests that QE would have resulted in amonetary expansion equivalent to a 380 bps reduction in the Refi rate. The data may therefore suggest that, in the current environment, a 380 bps reduction in the Refi rate has the same macroeconomic impact as a reduction of just 100 bps in normal times. One possible explanation for this discrepancy is that the transmission of monetary policy weakens when interest rates are already very low. For example, at current levels the cost of credit for companies and households cannot fall much further without compromising the solvency of banks, which are key in the transmission of monetary policy. It is also possible that the financial volatility with which the programme has coexisted has made it less effective.
In short, our estimates show has QE has a significant positive impact.4 However, they also indicate that the effect on the economic level is not immediate and the maximum impact appears after about two years. It is therefore important for the ECB and markets to be patient and give the measures time to take effect. Answering our initial questions, QE is capable of providing a strong boost for activity but precisely for this reason it is important to give the economy enough time to absorb the considerable easing of monetary policy occurring in 2015.
1. See the Focus «QE: the ECB is going shopping» in MR12/2015.
2. For our estimate we have used a vector autoregression model with the year-on-year growth rate for quarterly GDP, year-on-year core inflation and the shadow interest rate between December 1999 and December 2015.
3. See the Focus «Discovering monetary policy in the shadow» in MR02/ 2016.
4. An internal analysis by the ECB itself points to similar effects: a 1% increase in GDP between 2015 and 2017 and a 50 bps increase in inflation in 2016 and 33 bps in 2017.