Quantitative easing gives banks a 'free lunch'

30 January 2015

European banks are set for a free lunch as quantitative easing (QE) could lead to buying over-priced poor quality assets.

Research currently being undertaken by Lei Mao, of Warwick Business School, has found that it is difficult for central banks to monitor the quality of the assets they are buying in such large amounts when unleashing QE

The European Central Bank (ECB) is bidding to revitalise the euro zone by buying €60 billion (£44.8 billion) of bonds a month, following the UK’s and US’s QE programmes that have helped deliver growth after the financial crash.

But Dr Mao, Assistant Professor of Finance, warned that it is likely to lead to a lot of money being wasted on poor quality assets.

“My research at the micro level points out that a central bank's repurchase of assets in the private sector, incentivises private banks not to monitor the quality of their assets, and thus the monitoring effect of the European financial system might be harmed.

“In reality, a concern widely exists that if the ECB is not informed about the detailed quality of the assets to be repurchased, QE would most likely result in buying over-priced private assets and providing private banks a virtual free lunch.”

Despite this concern Dr Mao believes QE is a necessary risk given the parlous state of the euro zone economy and it should have been done sooner. 

“Any kind of micro level statement to explain why QE can be a waste of money has to be challenged by the current macroeconomic conditions of the euro zone,” said Dr Mao. “The very real risk of deflation, the slowing down of aggregate demand and investment, the lack of credit for private companies, the high unemployment rate in some countries, and many more reasons means the ECB has to act, though these problems should have been addressed a long time ago. QE is the last policy tool ECB President Mario Draghi can use, it has become strictly necessary.”

The ECB have said it will buy more than €1 trillion in assets purchases, which will include government debt, asset-backed securities and covered bonds, but not corporate bonds, to try to push inflation from its current 0.3 per cent to two per cent.

Dr Mao said: “Looking at the macroeconomic condition of the euro zone, most academics including myself, certainly support the ECB's QE. In fact, I have been waiting for the ECB's QE for quite some time.

“Now with Draghi clearing away obstacles to QE, mainly caused by Germany's absurd belief in austerity, I hope the generous spending will at least have some positive effects on the euro zone economy.

“In fact this should have been done a long time ago. QE would have been much more effective if it had been implemented before Germany's economy started showing signs of slowing down, or even before the private banking sector in the euro zone countries stopped providing sufficient credit to private companies as they are full to capacity with government bonds.

“Germany’s obsession with austerity measures has blocked QE until now, but as it is finally rolled out in a larger-than-expected capacity, it could, ironically, be the German economy that benefits most from it.” ?

Dr Lei Mao teaches on the Corporate Finance Management module of the MSc Finance & Economics.

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