A court opinion issued on Wednesday makes it all but certain that the European Central Bank will announce a major round of economic stimulus next week, after months of contentious internal debate.
But much mystery remains about how the bank will deploy quantitative easing - buying government bonds on a large scale to pump money into the economy.
The central bank still needs to decide the amount and the mix of bonds, including whether riskier nations such as Greece should be avoided. They must also navigate thorny political issues, like the concerns of Germany, whose opposition to ECB bond-buying has long been the main impediment to action.
It is a moment of truth for the central bank and a test of whether its president, Mario Draghi, can finesse the details while leaving no doubt about his institution's resolve to reinvigorate the Euro zone economy.
If it is not big or broad enough, the program might not work to revive the region. And many of the economists who have been saying for a year or more that the European Central Bank needs to take this stimulus step contend that when the move finally comes, it could be too little, too late. Some even predict that at its much-anticipated meeting next week, the central bank will announce only its intention to engage in bond-buying and wait until the next meeting, in March, to provide the details.
"They have always been too late," said Adalbert Winkler, a former economist at the central bank who is now a professor at the Frankfurt School of Finance and Management and an advocate of quantitative easing. "The last five years, if they had been more aggressive, maybe we could have avoided this discussion."
A solid majority on the central bank's 25-member Governing Council appears, based on recent public statements, to favour broad bond-buying. Their position was strengthened by the opinion submitted to the highest European appeals court on Wednesday in response to a lawsuit by German citizens seeking to block a previously planned bond-buying program that Draghi announced in 2012 but never deployed.
The opinion, by an adviser who considers legal arguments for the court, affirmed the European Central Bank's freedom to intervene in bond markets, with only minor restrictions. The opinion - it is not binding, but the court typically follows such guidance - could also help insulate the central bank from future lawsuits by warning lower courts to be cautious about interfering in monetary policy.
In principle, quantitative easing is simple and well tested. It has been used by the Federal Reserve in the US, which began a series of bond-buying programmes in the aftermath of the financial crisis that is credited with helping to revive the American economy. Britain, too, has used quantitative easing to similar effect.
Under such a programme, the central bank buys large amounts of government bonds and other assets, paid for with newly created money. Such purchases help drive down market interest rates, inject money into the economy and push inflation up from dangerously low levels considered incompatible with growth.
After that, it gets complicated.
Should the European Central Bank buy bonds from all 19 Euro zone countries, and in what proportions? If from all Euro zone members, then how should it handle Greece? The country is poised to elect a new government that could repudiate some of the billions of euros of loans the country owes as part of its international bailout. And how to keep the Germans on board?
Draghi has resolved to jolt inflation back to the central bank's official target of "below, but close to" 2 per cent. And yet, consumer prices fell at an annual rate of 0.2 per cent in December, raising the specter of a downward price spiral that could further undercut wages and growth.
Because of the large number of unanswered questions, the European Central Bank may not be ready to announce details of a bond-buying program next week.
"It's almost impossible for the ECB in this environment not to act," said Mujtaba Rahman, an analyst at Eurasia Group. But, he said, "We think it's a two-step move - announcement in January, further details in March."
Some elements of such a program are a given. The central bank would buy bonds on the open market - not directly from governments, which would be a violation of its charter.
But the bank will have to figure out how to deal with the lack of Pan-European assets comparable to the United States Treasury bonds that the Fed purchased in its quantitative easing programme.
The simplest and most likely option would be to buy bonds in proportion to each Euro zone country's share of the central bank's capital, which is calculated according to each member state's population and gross domestic product.
The drawback to this method is that it would mean buying large quantities of German government bonds, which are already in heavy demand - so much so that on Wednesday the yield on the 10-year German bond reached a new low.
Germany accounts for 18 per cent of the European Central Bank's capital, more than any other country. (Malta, with 0.65 per cent of the central bank's capital, has the smallest share.) Market interest rates on some other German government bonds are already below zero. So it is not clear what purpose, if any, would be served by pushing the rates even lower, as would happen if the European Central Bank started buying.
A second option would be to buy only highly rated government bonds - those of France, Finland and Germany, say, while avoiding the bonds of governments with riskier finances, like Portugal or Greece. That approach would answer German concerns that taxpayers could be stuck with the bill if some Euro zone governments were to default on their debt.
In theory, if the European Central Bank drove up the prices of highly rated bonds, private investors would turn to the bonds of weaker countries instead. But it is not certain that would happen. If not, the E.C.B. would not achieve its goal of providing relief in heavily indebted countries like Italy.
A third option would be to buy bonds in proportion to the outstanding debt of each eurozone country - the higher the debt level, the more bonds the central bank would buy. This alternative would favor countries that are the most deeply in debt and need the most help, like Italy. But conservative critics in Germany would probably complain that these countries were being rewarded for irresponsibly running up huge debts.
Every option has negative side effects. But Mr. Winkler of the Frankfurt School of Finance and Management said that did not mean the central bank should sit on its hands. "If you are about to drown," he said, "you don't worry about the possibility of having a heart attack a week later."
Whatever the method used by the central bank, the next big question is how much to buy. The central bank has implicitly set a target of expanding its balance sheet, a measure of the volume of its stimulus, by 1 trillion euros, or about $1.18 trillion.
The bank has already been buying private sector assets, including bundles of real estate loans. But the amount so far, about €33 billion, is clearly inadequate to meet the balance-sheet goal. Most of the rest would have to come from government bonds, the most abundant asset available.
Analysts at Nomura in London estimate that the European Central Bank would have to spend at least €700 billion on eurozone government bonds. But rather than setting the long-range target, Nomura analysts said in a note to clients last week, the central bank will probably announce monthly targets of around €55 billion, which could be adjusted to reflect changes in the inflation rate or other economic developments.
Among economists, there is widespread skepticism about whether any amount of bond-buying will solve the eurozone's growth and inflation problem. There is already plenty of money in the system, they say. The problems, many economists argue, lie in economic drags that are beyond the control of Mr. Draghi and the central bank - that it takes too long to get a building permit in Italy, for example, or that there are too many restrictions on hiring and firing in France.
"I don't think what he does," said Carl B. Weinberg, chief economist of High Frequency Economics in Valhalla, N.Y., "is going to make any difference for the economy."
But much mystery remains about how the bank will deploy quantitative easing - buying government bonds on a large scale to pump money into the economy.
The central bank still needs to decide the amount and the mix of bonds, including whether riskier nations such as Greece should be avoided. They must also navigate thorny political issues, like the concerns of Germany, whose opposition to ECB bond-buying has long been the main impediment to action.
It is a moment of truth for the central bank and a test of whether its president, Mario Draghi, can finesse the details while leaving no doubt about his institution's resolve to reinvigorate the Euro zone economy.
If it is not big or broad enough, the program might not work to revive the region. And many of the economists who have been saying for a year or more that the European Central Bank needs to take this stimulus step contend that when the move finally comes, it could be too little, too late. Some even predict that at its much-anticipated meeting next week, the central bank will announce only its intention to engage in bond-buying and wait until the next meeting, in March, to provide the details.
"They have always been too late," said Adalbert Winkler, a former economist at the central bank who is now a professor at the Frankfurt School of Finance and Management and an advocate of quantitative easing. "The last five years, if they had been more aggressive, maybe we could have avoided this discussion."
A solid majority on the central bank's 25-member Governing Council appears, based on recent public statements, to favour broad bond-buying. Their position was strengthened by the opinion submitted to the highest European appeals court on Wednesday in response to a lawsuit by German citizens seeking to block a previously planned bond-buying program that Draghi announced in 2012 but never deployed.
The opinion, by an adviser who considers legal arguments for the court, affirmed the European Central Bank's freedom to intervene in bond markets, with only minor restrictions. The opinion - it is not binding, but the court typically follows such guidance - could also help insulate the central bank from future lawsuits by warning lower courts to be cautious about interfering in monetary policy.
In principle, quantitative easing is simple and well tested. It has been used by the Federal Reserve in the US, which began a series of bond-buying programmes in the aftermath of the financial crisis that is credited with helping to revive the American economy. Britain, too, has used quantitative easing to similar effect.
Under such a programme, the central bank buys large amounts of government bonds and other assets, paid for with newly created money. Such purchases help drive down market interest rates, inject money into the economy and push inflation up from dangerously low levels considered incompatible with growth.
After that, it gets complicated.
Should the European Central Bank buy bonds from all 19 Euro zone countries, and in what proportions? If from all Euro zone members, then how should it handle Greece? The country is poised to elect a new government that could repudiate some of the billions of euros of loans the country owes as part of its international bailout. And how to keep the Germans on board?
Draghi has resolved to jolt inflation back to the central bank's official target of "below, but close to" 2 per cent. And yet, consumer prices fell at an annual rate of 0.2 per cent in December, raising the specter of a downward price spiral that could further undercut wages and growth.
Because of the large number of unanswered questions, the European Central Bank may not be ready to announce details of a bond-buying program next week.
"It's almost impossible for the ECB in this environment not to act," said Mujtaba Rahman, an analyst at Eurasia Group. But, he said, "We think it's a two-step move - announcement in January, further details in March."
Some elements of such a program are a given. The central bank would buy bonds on the open market - not directly from governments, which would be a violation of its charter.
But the bank will have to figure out how to deal with the lack of Pan-European assets comparable to the United States Treasury bonds that the Fed purchased in its quantitative easing programme.
The simplest and most likely option would be to buy bonds in proportion to each Euro zone country's share of the central bank's capital, which is calculated according to each member state's population and gross domestic product.
The drawback to this method is that it would mean buying large quantities of German government bonds, which are already in heavy demand - so much so that on Wednesday the yield on the 10-year German bond reached a new low.
Germany accounts for 18 per cent of the European Central Bank's capital, more than any other country. (Malta, with 0.65 per cent of the central bank's capital, has the smallest share.) Market interest rates on some other German government bonds are already below zero. So it is not clear what purpose, if any, would be served by pushing the rates even lower, as would happen if the European Central Bank started buying.
A second option would be to buy only highly rated government bonds - those of France, Finland and Germany, say, while avoiding the bonds of governments with riskier finances, like Portugal or Greece. That approach would answer German concerns that taxpayers could be stuck with the bill if some Euro zone governments were to default on their debt.
In theory, if the European Central Bank drove up the prices of highly rated bonds, private investors would turn to the bonds of weaker countries instead. But it is not certain that would happen. If not, the E.C.B. would not achieve its goal of providing relief in heavily indebted countries like Italy.
A third option would be to buy bonds in proportion to the outstanding debt of each eurozone country - the higher the debt level, the more bonds the central bank would buy. This alternative would favor countries that are the most deeply in debt and need the most help, like Italy. But conservative critics in Germany would probably complain that these countries were being rewarded for irresponsibly running up huge debts.
Every option has negative side effects. But Mr. Winkler of the Frankfurt School of Finance and Management said that did not mean the central bank should sit on its hands. "If you are about to drown," he said, "you don't worry about the possibility of having a heart attack a week later."
Whatever the method used by the central bank, the next big question is how much to buy. The central bank has implicitly set a target of expanding its balance sheet, a measure of the volume of its stimulus, by 1 trillion euros, or about $1.18 trillion.
The bank has already been buying private sector assets, including bundles of real estate loans. But the amount so far, about €33 billion, is clearly inadequate to meet the balance-sheet goal. Most of the rest would have to come from government bonds, the most abundant asset available.
Analysts at Nomura in London estimate that the European Central Bank would have to spend at least €700 billion on eurozone government bonds. But rather than setting the long-range target, Nomura analysts said in a note to clients last week, the central bank will probably announce monthly targets of around €55 billion, which could be adjusted to reflect changes in the inflation rate or other economic developments.
Among economists, there is widespread skepticism about whether any amount of bond-buying will solve the eurozone's growth and inflation problem. There is already plenty of money in the system, they say. The problems, many economists argue, lie in economic drags that are beyond the control of Mr. Draghi and the central bank - that it takes too long to get a building permit in Italy, for example, or that there are too many restrictions on hiring and firing in France.
"I don't think what he does," said Carl B. Weinberg, chief economist of High Frequency Economics in Valhalla, N.Y., "is going to make any difference for the economy."
©2015 The New York Times News Service