Barclays: Quantitative Easing Delivers Significant Fiscal Benefits, But Don’t Get Complacent

By Mark Melin 

Quantitative easing and “ultra-accommodative monetary policy” have delivered significant fiscal benefits to the European Union, a Barclays report notes. But the report, titled “QE’s fiscal high will not last forever,” pointed to moral hazard concerns that a habit-forming dependency can bring about.

Quantitative easing has reduced fiscal pressures on debt-ridden governments

In a region where sovereign debt has been a concern, particularly in periphery nations, one of the most significant benefits of untraditional monetary policy can be seen can be seen in how it cools down the region’s debt problems.

“One of the most prominent features of the global financial crisis has been the large accumulation of public debt, especially in those countries where the crisis was most severe” Barclays Economics Research team leader Antonio Garcia Pascual wrote. “The reason for the very large accumulation of public debt can be traced back to weak GDP growth, a decline in fiscal revenues, an increase in unemployment-related outlays and financial sector bail-outs.”

From 2014-16, Barclays modeling reveals average funding costs resulting from quantitative easing have fell by 110 basis points, and in Italy and Spain they fell by 147 and 155 basis point, respectively.

With notable debt to GDP levels in Greece at 178%, Italy 132%, Spain at 99% those nations along with other high-debt nations benefit in the land of low if not negative interest rates. Without quantitative easing, Italy and Spain’s public debt-to-GDP ratios, for instance, would have increased an “alarming” 12% each between 2014-16 rather than the actual 4.5% and 5.3% debt to GDP growth, the report noted.

Quantitative easing benefits fiscal budgets

Regional governments have done well in balancing the need to balance their budgets, with QE easing the way. But concerns on the political horizon exist. “Populist threats bring another layer of complexity,” the report noted, pointing to increased pressures for governments to spend more money and potentially tip a delicate balance.

High debt levels do not necessarily correlate 100% to a sovereign crisis, particularly when a government spends money wisely and collects taxes efficiently, the report noted. But if that doesn’t happen, “solvency concerns could re-emerge, sovereign interest rates quickly rise above the average funding costs.”

If a market dynamic occurs such as that following 2009 where stimulus was required to jump-start the economy, there could be concerns. “The big difference is that this time there would be far less monetary, fiscal, and political space to confront them.”

Moral Hazard: The path of least resistance may be submitting to the addiction of quantitative easing, but its stimulative power won’t last forever

In order for the European economic machine to work smoothly, it could require difficult choices that accompany structural reform: ridding government of corruption, inefficiency and waste. Herein lies the problem.

Faced with the choice of angering deeply entrenched governmental, union and social interests opposed to structural reform or simply continuing to depend on quantitative easing, the path of least resistance for government is clear.

This is not sustainable, however. “QE is not forever,” Mario Draghi famously warned. “Debt sustainability issues will resurface not only because of higher interest payments but also, critically, because long-term growth prospects are dismal without reforms,” the report noted, pointing to a growing dependency. “This could in turn require ‘permanent QE’ to avoid a fiscal crisis. The great fiscal success of QE could therefore turn out to be its biggest downfall.”

In the short term political leaders can make an easy choice or a difficult choice that benefits the long-term, pointing to a dichotomy Barclays recognizes:

QE, just like any monetary policy, can only lead to a temporary increase in growth. But by easing the pressure from the bond market, QE has lead to fiscal policy loosening and a slowing in structural reform momentum, which will likely impede future growth. This could easily lead to a situation where ‘permanent’ QE is necessary to prevent a fiscal crisis. Monetary authorities need to therefore undertake a careful balancing act to ensure that the economy does not get stuck in a low-growth equilibrium trap.

Unfortunately, in a democracy, when political leaders and voters are given a choice between the easy solution with short-term results and the difficult choice that delivers long-term and often unseen benefits, it is not difficult to determine the path that is likely to be taken.