Don’t know what quantitative easing is?

What is quantitative easing (QE)? It is a move by a central bank to inject more cash into the economy. QE involves a central bank creating new money

electronically and using this to buy assets, normally government bonds. (Government bonds are issued by governments promising investors an interest rate return and their money back at a fixed time in the future). By buying these bonds from investors or banks the central bank is giving these parties more cash to lend out of invest elsewhere.

QE is also designed to drive down interest rates, not only official rates, but also those charged to borrowers. It should also lower the value of the currency, helping exporters and pushing up import prices. QE is also designed to improve confidence in the future by consumers and investors, thus encouraging them to spend more.

Why is the ECB doing it now ?

The ECB has a target of keeping the annual rate of inflation at close to 2 per cent. However the latest figures showed that prices were actually falling – down 0.2 per cent annually in December – partly due to falling oil prices. If this deflation, where prices fall, becomes entrenched, it can have dangerous economic effects. Interest rates , the usual policy used by a central bank to control the level of activity, are already at historical lows, so the ECB is making the unorthodox move to QE, a road already taken in the US, UK and Japan.

What is the size of the programme?

The total size of the QE programme will be €60 billion a month up to at least September 2016 – this is the total amount of assets which Euro central banks will buy, most of them government bonds. This suggests a total of over €1.1 trillion and is more than markets had expected, even though it also counts smaller programmes already underway. Bond purchases will be based on the size of the economy (as measured in each country’s capital share in the ECB).

Does everyone agree QE is a good idea?

No. The Germans have severe reservations. Germany has historic fears that monetary expansion of this kind can fuel inflation in the longer term. More immediately, there are fears in Germany that if the ECB buys up bonds of peripheral countries, it may remove pressure on them to correct their public finances and reform their economies, or leave Germany on the hook if countries default.

Was the programme changed to meet German concerns?

Yes. Most of the bonds will be bought by the national central banks, rather than the ECB itself, though the ECB will still manage the whole operation. ECB president Mario Draghi says that just 20 per cent of the new bonds purchased will be subject to “risk sharing” – in others words the bulk will rest with the national central banks and their governments.

This sends out the political message that each country is largely responsible for itself. This would go down well in Germany, though possibly poorly in the financial markets if they feel it undermines in any way the unitary nature of the euro zone.

National central banks’ annual profits will be affected by the purchase and sale schedule of the bonds they buy. However many economists argue that the move to get national central banks to take most of the bonds on to their books does not, in fact, really expose the different central banks or their governments to serious risks – for example in the case of a sovereign default – given the peculiar nature of central bank balance sheets and the tools available to governments to recapitalise them if needed.

There will also be a budget boost for member states as their own central banks buy bonds, as governments will be paying interest on these bonds to their own central bank, whose profits are returned to the exchequer at the end of the year.

What will it mean for Ireland?

First, we must hope that it revives growth and keeps the euro low on foreign exchange markets, which would help our exporters. Higher inflation would also be welcome as, together with growth, this could chip away at our debt burden. Inflation also benefits indebted households.

If QE helps to keep interest rates low, then this will allow the government to continue to raise fresh funds on the market at cheap rates, benefiting the annual budget. Low interest rates also help borrowers – provided they are passed on – but the outlook for savers remains poor. An injection of cash should boost the availability of loans to households and businesses and hopefully reduce the interest rates charged to them a bit. However the bigger problem at the moment is the demand for credit, not the supply of it.

While we have still to see the full details of the scheme, the announcement suggests that it will involve €500 million approximately in purchases of Irish government bonds by the Central Bank of Ireland each month, or over €9.5 billion by September 2016.

This would be significant in a market which has just €116 billion of bonds in issue. The Central Bank already holds €25 billion in Irish bonds after the promissory note deal so it remains to be seen if there will be any limit put on its additional purchases due to this.

More demand for bonds should keep interest rates low. It will also deliver some limited benefit to the government finances as it will pay interest on the bonds to our own Central Bank (as opposed to another investor) which in turn repays the bulk of its profits to the exchequer.