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Explainer: Why the ECB will be pulling €1.1 TRILLION out of thin air... and what it means for you

The European Central Bank’s €1.1 trillion QE plan starts today.

Updated 9 March, 6.53am

ECB president Mario Draghi ECB president Mario Draghi Source: Michael Probst/AP/Press Association Images

THE EUROPEAN CENTRAL BANK will begin its €1.1 trillion quantitative easing programme today, the last big weapon in its armoury to get the eurozone going and fend off deflation.

But what on earth is quantitative easing and why did the bank’s president, Mario Draghi, and his cohorts make this call? Here’s everything you need to know…

What is quantitative easing and why are they doing it?

Quantitative easing – or QE for short - basically means the ECB will start creating money out of thin air. All those new euro would then be used to buy assets in the hope that getting more money flowing across the common currency bloc will inspire extra spending from governments, businesses and individuals.

The main drivers for the move are twofold. Firstly, the eurozone has been stuck in a cycle of high unemployment and low economic growth with little relief on the horizon.

Secondly, the region slipped into the deflation zone in December, meaning that average prices went down. Central banks generally consider an inflation figure of about 2% to be healthy and governments fear rampant deflation because it can send tax revenues and other sources of income into a painful downward spiral.

Eurostat Source: Eurostat

And they’re allowed to do this?

Yes, the ECB can. Because central banks control the national purse strings they retain the right to create more of their own currency at will. In the normal world, that normally means printing more money to replace coins and notes taken out of circulation. But in the QE world it means creating cash to buy things it couldn’t afford before.

However, the eurozone is a special case. Individual member states, like Ireland, don’t have the right to create extra cash as the ECB wields sole power over the euro. In fact, members are expressly banned from printing extra money to prop up their finances.

That is the reason why this country’s infamous promissory notes, used to stem the bloodletting after the collapse of Anglo Irish Bank, had to be unwound – because they amounted to the government creating money to prop up the failed bank.

Does the ECB literally start printing more money?

Not any more. While the visual of Draghi handing out of wads of €100 bills is appealing, the reality is the whole process would be done electronically. The ECB account keepers will simply add more money to its balance sheet – and then set about spending that money.

WCENTER 0WHCADPCDM - ( Aenzia EMBLEMA - DRAGHI_02.jpg ) Source: giannischicchi78

However one key difference between QE, in this form, and the kind of catastrophic money-printing policies associated with Germany in the 1920s is that central banks still have to buy assets on financial markets – rather than simply handing the cash straight to a government to fund spending.

The package being launched today includes plans for the ECB to buy about €60 billion public and private bonds every month between now and September 2016.

What’s with the name, can’t they just call it what it is?

That would be way too easy. The ”easing” part of the term actually refers to the relaxing of pressure on banks, while the ”quantitative” is a nod to the fact a set amount of money is being spirited into existence.

Photo-0011 Source: mittfh

So who gets this money? Can I expect a cheque in the post?

You should be so lucky. None of the newly-invented cash will actually be headed to the pockets of EU citizens – although it has been suggested that would be a better way to stimulate the economy than the mooted plans.

Instead, QE in the eurozone will almost certainly involve the ECB buying government bonds – representing money that has been borrowed by those EU member states – from banks and other institutions. The idea is that all that extra demand pushes down the cost of borrowing, making it easier for countries to spend money on other things that get their economies going – like infrastructure or tax breaks.

Also the banks who have sold the ECB all those bonds would now have more cash to spend and, so the theory goes, this means they will start lending money to more people and businesses at lower rates – again driving economic growth.

Money Source: Tumblr

What does it all mean for Ireland?

If all goes to plan with QE, it would have a number of positive effects for Ireland as a whole. Firstly, the flood of extra money would push the value of existing euro down – meaning the currency is worth less compared to the pound or the US dollar.

While currency traders have already factored in some of this on expectations of QE, it means Ireland’s exports to countries outside the currency block would get more competitive, hopefully increasing demand.

And if the plan successfully stimulates the eurozone that would also be a good thing, assuming member states, their companies and citizens all start spending more money on Irish exports too.

Higher demand for government bonds leads to lower interest rates on them, meaning the government would be able to borrow money more cheaply in the future – another win as the country tries to unwind its €180 billion-odd mountain of debt.

Irish budget 2015 Finance Minister Michael Noonan Source: Niall Carson/PA Wire/Press Association Images

More importantly, what about you and me?

Not so much good news for the average punter, unfortunately. The main direct effect of QE for consumers is to drive the currency’s value down, potentially as low as equal footing with the dollar according to some analysts. That means, proportionally, the euro you have in the bank will be worth less than they were before – although the good news is any debts, such as your mortgage, are also worth less.

A low euro also means more expensive imports from outside the eurozone – everything from that new iPhone to the clothes you wear. And a holiday across the Atlantic or over to the UK will be less appealing as your euro no longer goes as far overseas.

USD Source: xe.com

Is this the first time anyone’s done this?

The US, UK and Japan have all tried their hands at QE, but the jury is still out on how effective the policy has been. The Asian nation the first to use the radical concept in the early 2000s, while the US and UK both turned on the cash taps after the financial crisis.

Particularly in the US, where QE has been worth about $3.5 trillion (€3 trillion) in total, the economy has rebounded sharply – although some have argued this would have happened anyway without the cash splash.

Europe’s programmes is said to be similar to that of the US Federal Reserve and Bank of England.

Obama Source: Charles Dharapak/AP/Press Association Images

Why wait until now – wasn’t there a financial crisis a few years ago, or did we all dream that?

QE doesn’t come without risk, which is why it has been a controversial move wherever it has been rolled out. The primary fear is that all that extra money will suddenly cause inflation to balloon out of control, slicing the value of savings and assets across the region.

But the ECB has already tried every other trick in its bag to lift inflation and stimulate growth, with QE the only lever so far left untouched. It has already cut interest rates to record lows and gone on a bond-buying spree with existing reserves, neither of which has delivered a big enough bang to kickstart widespread recovery.

Germany, the most powerful eurozone economy, has also been leading the fight against the policy. Part of this stems from concerns that giving struggling countries access to easy money will reduce the incentive for them to come up with long-term fixes for their balance sheets.

Another worry is that the ECB – and by extension, other eurozone member states – will be left holding the can if it buys bonds from the most volatile economies, like Greece, and they default on their debts.

What’s the connection between QE and Katie Price?

Ah, we’re glad you asked. In a suprise 2012 move, the former glamour model suddenly started tweeting about macroeconomic policy, turning her thoughts to everything from Chinese GDP figures to this musing on QE:

She later denied her account had been hacked, with a publicity stunt emerging as the most likely explanation. So there you go.

Katie Price Book Launch - London Source: Doug Peters/Doug Peters/EMPICS Entertainment

Originally published 8am 21/01/2015

READ: The head of the ECB is greasing markets for a money-printing injection >

READ: Explainer: Why a ‘grexit” would be bad news for Ireland… but probably won’t happen >

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About the author:

Peter Bodkin  / Editor, Fora

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