What are the Critical Success Factors (CSF) for a Quantitative Easing (QE) program? This sounds like an easy question, but there are so many layers of actions involved that there are just as many CSFs to achieve.

Take Draghi’s European QE program, for instance. What are the CSF’s? Here is the list in order of policy importance:

CSF 1. Raise inflation and employment by expanding the monetary base.
CSF 2. The money that is created needs to be lent to the private sector and spent
CSF 3. Interest rates must fall across the yield curve
CSF 4. The regional Central Bank’s must execute Euro 1.2 Trillion of domestic bond purchases over 20 months (Euro 60B per month) to expand the money base.

This is a tangled web indeed and, frankly, success with the main policy objective of raising inflation and employment (CSF 1), depends on success of CSF’s 4, 3 and 2 respectively. In fact, CSF 4 is the only mechanical achievable. The remaining CSF’s do not instantly flow from that achievement. For instance,

CSF3. There is no assurance that interest rates will fall if the ECB succeeds on buying EUR 60 billion per month. There is always two sides to a market, and while demand for European Government bonds is higher due to ECB purchases, the supply response from countries issuing new bonds has been phenomenal – this week has witnessed EUR 20 billion of new government issues from Italy, Spain, Belgium and the Netherlands. The ECB’s purchases may well not keep up with the pace of new issuance!

CSF2. Call me a ‘Classicist’, but aren’t real interest rates determined by the marginal product of capital? What makes private investors and borrowers adjust their risk and return expectations for productive assets just because the ECB decides to expand their balance sheet? Capital budgeting decisions depend on things like output prices, labour costs, technology and taxes. Not much mention of Mr Draghi in that list.

CSF1. Finally, all this must result in higher inflation and employment.