In January 2015, the European Central Bank (ECB) took the unprecedented move of announcing that they would undertake quantitative easing (QE) in order to stabilize the faltering eurozone economy. Quantitative easing is an unconventional monetary policy tool whereby the central bank purchases non-treasury securities in the open market, effectively injecting money into the system. The question is whether quantitative easing is hurting the value of the shared currency, the euro? (For more, see: How Unconventional Monetary Policy Works.)

Euro Woes Before QE

The eurozone has been plagued by economic trouble from its periphery member states since the Great Recession of 2008. High levels of sovereign debt made worse by government corruption has stigmatized the so-called PIIGS nations – Portugal, Italy, Ireland, Greece and Spain. While the central EU nations saw their economies recover, the periphery was subject to bailout packages requiring significant cut backs and austerity measures.

Greece, especially, has remained a thorn in the side of the economic recovery in Europe, with renewed threats to exit the euro currency and allow its economy to reboot, even though the consequences would be severe for both Greece and the rest of the euro members. (See also: European Union Breakup: Greek Euro Exit.)

The euro began trading against the dollar in 2000, and its value had steadily strengthened over time. Just prior to the Great Recession, in the summer of 2008, the euro reached an all time high of nearly 1.60 dollars per euro. It subsequently fell in value to under 1.20 dollars per euro and has since fluctuated in a range between 1.23-1.43.

During 2014, the euro steadily lost value to a modest extent, declining nearly 12% from around 1.375 dollars per euro to 1.220.

The Euro Since Quantitative Easing

The data shows that the value of the euro was declining steadily in the year leading up to the decision to undertake quantitative easing. Its value has fallen an additional 16% since, to around 1.05 dollars per euro – price levels not seen since the early 2000s.

Inflation levels in the eurozone have been historically low in recent years, with some countries even experiencing deflation, a general decline in price levels. Deflation is a bad thing for economic growth, as it is indicative of low aggregate demand and underlying weakness in production and output. Individuals and businesses stop spending and investing and begin to hoard money as a safety cushion against further declines in asset values. Companies lay off workers and unemployment rises preventing an economic recovery from taking place quickly. As expectations that low prices will stay persistent, people choose to hold on to money rather than spend it as its perceived value will be greater in the future. Credit and liquidity subsequently dry up and the situation descends deeper into recession or depression. This is known as a deflationary spiral. (For more, see: Why is Deflation Bad for an Economy?)

When prices drop like this, central banks generally employ expansionary monetary policy tools, but in severe cases quantitative easing is required. The ECB is trying to prevent a deflationary spiral at all costs, and some banks in Europe are even going so far as to implement a negative interest rate policy (NIRP). If deflation is when goods get less expensive to buy, that implies that the currency must be getting stronger. If this is the case, why is the euro weakening?

Hypothetical Greek Euro Exit

One important piece of the puzzle is the lingering threat that Greece will exit the euro. A new anti-austerity government has been butting heads with European finance ministers, and now more than ever, the threat of a Greek exit is real. The consequences would be disastrous for the euro as other peripheral nations could decide to follow suit and the dominoes will then fall. Greece's economy in and of itself is not very large, however the ripple effects of contagion from a Greek exit would be widespread. As a result of these developments, the increased risk of such a move by Greece is being factored in to the euro exchange rate, weakening it against the dollar. (For more, see: If Greece Leaves The Euro, Who's Next?)

QE itself is surely to have some impact on the euro's value as its intention is to decrease the value of money in order to spur spending and investment. Quantitative easing, however, did not significantly increase annual inflation rates in the United States after a number of rounds and over a period of many years. The likely reason is that while QE increases the monetary base to shore up financial institutions' balance sheets, the data show it does little to create new credit money through fractional reserve banking, which is arguably a much more important metric when looking at price levels. (See also: Why Didn't Quantitative Easing Lead To Hyperinflation?)

The Bottom Line

Quantitative easing being undertaken by the ECB in order to stabilize the eurozone economies is sure to have some impact in decreasing the value of the euro. That said, the EUR/USD exchange rate has been falling steadily for more than a year leading up to the decision to begin QE. The real threat of a Greek exit and the contagion it will cause throughout the rest of the periphery is one factor that has been contributing to this extended decline. While QE is likely to have some effect on the euro's value, many rounds of quantitative easing in the United States has not led to a great deal of inflation. Quantitative easing is meant to stave off deflation and prevent the eurozone from descending into a deflationary spiral.


Want to learn how to invest?


Delivered twice a week, straight to your inbox.