Endividamento - Antonio Gaspar

The ECB’s Monetary Policy

The ECB did a great deal to help combat the crisis, starting with the banking turmoil in 2008, the sovereign debt crisis from 2010 onwards and later the prolonged low inflation.
In doing so, it took a number of measures. Some of them form part of conventional monetary policy, others are new or, at least for the euro area, unusual.

Thus, when inflation remains too low for a long time it’s a conventional measure for a central bank to lower interest rates. The idea behind this is as follows: the lower the interest rates are, the more attractive it is for companies to invest and for people to consume. Demand goes up, as do prices.

Yet this conventional monetary policy virtually became a new instrument in June 2014. For the ECB cut the deposit rate for banks to below zero – the zero lower bound was breached. Since then, banks have had to pay interest on their deposits at the ECB.

Do you find it strange to pay someone in order to lend money to them?
It is at the very least unusual, but there is a reason for it in this case. The idea is to encourage a bank to lend its money elsewhere – for example, to businesses. That is one effect of negative rates.

And there is a second effect – aimed at investors in the financial markets. It was made clear to them that short-term interest rates could fall below zero. Mindful of this, investors adjusted their interest rate expectations downwards; long-term interest rates have fallen. This has strengthened the desired effect on investment and consumption.

The low interest rates are now being severely criticised, particularly in Germany. It’s claimed that the ECB is penalising savers, destroying the banks’ business models and ultimately doing more harm than good.

In the past, my point of view in this debate was always that low interest rates are justified.
Interest rate cuts are the “normal”, the called-for, monetary policy measure of a central bank when inflation is well below the objective.

This is all the more the case when inflation remains low, when inflation expectations show no signs of improvement, when growth is very weak and unemployment rising. In such circumstances every other central bank would have cut interest rates.

That I am more critical of some non-standard monetary policy instruments, such as the purchase of government bonds, is well known.

However, the world keeps on turning and the debate moves on. The situation seems to be improving in the euro area. Consumer confidence in December was at its highest for 18 months. Unemployment is at a seven-year low. A broad-based recovery is under way – across countries and sectors.

At the same time, inflation in the euro area rose significantly – from 0.6% in November to 1.1% in December. In Germany inflation even stood at 1.7% in December.

And unsurprisingly, some are calling for the ECB to put a quick end to its loose monetary policy.

In terms of the desired level of inflation, it’s been a long, cold winter. We are now seeing the first ray of sunshine – that’s good. Is this ray already having a warming effect and does it herald the spring? Is inflation really back? Perhaps one or two more rays of sunshine are needed; they’ll bring a bit more warmth.

Higher inflation is currently being driven mainly by energy prices and they could well have only a temporary effect. What’s more important here is underlying inflation, from which the very volatile energy and food prices are excluded.

And underlying inflation in December was just 0.9%, after 0.8% in November. This rise was largely due to the fact that package holidays became more expensive in Germany. However, this does not tell us much as the prices of package holidays are always fluctuating.

Does this mean we still have to wait a long time before exiting accommodative monetary policy?

In my view it doesn’t mean waiting until the last doubt about the return of inflation has been dispelled. It is rather a matter of not risking a reaction to a temporary inflation spike – which then might lead to longer, exceptional monetary policy measures.

All preconditions for a stable rise in inflation exist. I am thus optimistic that we can soon turn to the question of an exit. That’s why we need to be ready to act when the time comes.
For loose monetary policy is like a strong medicine for someone who’s very sick. It works, no doubt, but it also has side effects – and some of the unconventional measures have stronger side effects than others. And while the intended benefits of these measures wear off over time, the side effects and risks increase.

That’s why it’s important to stop taking the medicine as soon as possible, but not too early either. Otherwise, we risk having a relapse.

And let me reassure you that, to stick with the metaphor, I am an optimistic doctor who believes in self-healing powers and gladly stops prescribing the medicine sooner rather than later.

And, above all, as with many medicines, you shouldn’t abruptly stop loose monetary policy, but slowly cut the dose – such a policy has to be reduced gradually.

In any case, loose monetary policy can help put a patient back on her feet, but by itself it can’t ensure that she’ll go on long walks again. Monetary policy cannot create sustainable growth. Other things are necessary.

 Sound economic structures form the basis for long-lasting growth; reforms are the right therapy.