ECB QE via FX: Plan B

My post last month was a proposal for the European monetary authorities to pursue Quantitative Easing, not by buying euro bonds, but by buying dollar bonds.   I also presented this idea in a speech at a conference sponsored by the Dallas Fed, April 4, “Why the ECB Should Buy US Treasuries.”

But what if the ECB is told by the international community, especially the US, that it doesn’t want them to push the euro down against the dollar, that it fears a re-ignition of the currency wars?   And what if the ECB concludes that it can’t buy US treasuries without US agreement?   After all, it was only February of last year that the G-7 Ministers and Governors agreed not to try to influence exchange rates.

I have a Plan B to propose in that case, a version of the idea that need not put downward pressure on the foreign exchange value of the euro.   The ECB still pursues QE by buying US bonds; but it buys them from the Fed rather than on the open market.

Recall that the goal is for the ECB to expand its monetary base, without flirting with illegality.  And that the Fed’s goal is to taper and then reduce its holdings of Treasury bonds and Mortgage Backed Securities, without yet forcing up long-term interest rates.

The argument is that everybody gets what he wants.  The Eurozone expands its monetary base.   The Fed gets to reduce the bonds on its balance sheet.  By selling them to the ECB rather than on the private market it avoids upward pressure on interest rates. (And what central bank doesn’t want more foreign exchange reserves, other things equal?)  If the ECB buys its dollar assets from the Fed instead of on the private market it avoids downward pressure on the euro.

The counter-argument from the viewpoint of the ECB is that, even though this is a way to expand its monetary base, it probably doesn’t achieve the objective of lowering Euro interest rates, if the Fed holds the euros as deposits at the ECB.  It would work if the Fed used them to buy longer-term euro bonds, which lots of central banks do these days.  But that idea would not go over well with the American public.  So maybe it has to be Plan A.

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