ECB caught in vicious cycle

During the height of the euro crisis in the summer of 2012, European Central Bank chief Mario Draghi pledged he would save the euro "whatever it takes." His rhetoric abruptly quieted down financial speculation against several eurozone member states. 

Thereafter, the ECB cut interest rates until its key refinancing rate hit zero percent this spring. In addition, commercial banks holding money with the ECB are being punished with a negative deposit rate. Moreover, the central bank supports struggling banks with emergency loans and free credit. After all, the ECB has launched a massive asset-buying program, also known as Quantitative Easing (QE) in the spring of 2015, meaning the bank acquires government and company debts at large scale, thus effectively printing and circulating more and more money.

Not surprisingly, Draghi appears happy with his extremely accomodative monetary policy. After all, inflation, credit volume and economic growth have all been on the rise in the eurozone, if only modestly. But take a closer look and it's hard to share Draghi's optimism. The return of inflation at very low levels - the last number was 0.5 percent - can be primarily traced back to rebounding price of crude oil and groceries.

By contrast, eurozone members fiscal policies have had precious little little effect on those mark-ups. The gush of newly-minted euros, instead, is keeping "zombie banks" and "zombi companies" artificially alive, as it fails to kickstart anemic growth in the euro currency area..

ECB takes reform pressure off countries

It isn't entirely speculative, therefore, that the ECB's monetary policy is part of the problem, not the solution. Deutsche Bank economist Stefan Schneider told DW that the willingness of eurozone governments to reform their economies has "markedly dropped after Draghi's whatever-it-takes announcement, especially in countries at the bloc's southern periphery" - a fact that has also been substantiated by OECD analyses, he adds.

The Organisation for Economic Cooperation and Development has found that higher interest rates before the 2012 debt crisis, had forced governments of crisis states to implement more than half of OECD's recommended growth initiatives. Last year, however, this share dropped to below 20 percent. This shouldn't come as a surprise: Draghi's promise, in conjunction with the bond purchase program, has minimized the difference in interest rates between German sovereign debt and those of crisis-hit states in the south of Europe. Without psychological strains, it is doubtful that politicians will go through with unpopular reforms when there is no fiscal pressure.

Further evidence comes from a study by Germany's biggest lender, Deutsche Bank, saying the ECB bond-buying has led to a decoupling of bond yields from political and fiscal risks of eurozone countries. "Bond prices have lost their signal function," the authors stated, adding that political measures posing a stability risk would no longer be penalized.

Savers are among those suffering from the prolonged low- and negative interest policy of the ECB, especially Germans, who tend to have few stock investments. Additionally, inflation in Germany is higher than in the rest of the eurozone. That's why several German economists are speaking of a creeping devaluation.

Inflating bubbles instead of creative destruction

In order to escape the interest rate trap, savers embark on a quest for higher-yielding investment opportunities. Amid concerns for their savings, many revert to real estate, which has already lead to property market bubbles, especially in Germany's bigger cities. With the ECB continuing to pump cheap money into markets, the eurozone central bank also prevents the creative destruction of ineffective companies and struggling industries. Without said creative destruction, investors will continue to drive up asset prices, the Deutsche Bank researchers purport.

According to the experts, the most far-reaching consequence of the ECB monetary policy is, however, a "growing strain" for the balance sheet of the euro system.

"In light of potential losses, a heartland country would theoretically have to carry the costs connected to the rescue funds, the quantitative easing program as well as losses from the Target 2 cross-border payment system of the eurozone. That makes it almost unimaginable for any member state to be left behind by the others," they conclude.

While rescue packages for individual members need to be ratified by national parliaments, the ECB is in a position to prolong and inflate the QE-program at will. It is estimated that by March 2017, the institution will have amassed 1.74 trillion euros ($1.85 trillion) worth of bonds, a sum far exceeding the combined firepower of the eurozone's existing bailout funds.

It looks like the ECB won't leave it at said sum. Growth in the eurozone is still subdued and inflation still low. Deutsche Bank's Stefan Schneider expects the ECB to extend the QE-program through the end of 2017 at the central bank's upcoming council meeting on Dec.8. Germany's second-largest lender, Commerzbank, shares the assumption, as well as Deutsche Bank's doubts about the ECB policy's effectiveness. "A basic question is which effect additional liquidity can have in the face of an already substantial liquidity surplus," the Commerbank analysts write.