When the price of a commodity falls, popular logic dictates that most people should all be happy. So is this different when the cost of money – a commodity that we are all familiar with – falls?
For the past few years central bankers seem to have been the only active managers of the world’s economies. Their most powerful tool has been the lowering of interest rates and they have used this tool frequently over the last four years.
By lowering interest rates, the ECB aims at making it easier for banks to lend to businesses who seem to have lost the appetite for taking risk which is the most essential element for economic growth. The downside of this monetary policy is that low interest rates penalise savers many of whom depend on interest income to support their quality of life. No wonder some critics have accused the ECB of ‘expropriating savings’.
Germany’s leading politicians, including Finance Minister Wolfgang Schauble, blame the rise of Alternative for Germany, the right wing Eurosceptic party, on the ECB’s low interest rates. Typical of political rhetoric, this is a superficial analysis of why people in Germany and the rest of the EU are becoming increasingly frustrated by traditional politicians.
In his latest press conference, ECB president Mario Draghi was justified in pointing his finger at the EU’s political leaders for the present economic stagnation. Mr Dragi said: “With rare exceptions, monetary policy has been the only policy in the last four years to support growth.”
We have now reached a level where interest rates are already in negative territory and they cannot go down much further
Put simply, lower interest rates for such a long period of time may have been only partially successful, but without the use of such a monetary tactic economic growth in Europe could have been even more sluggish.
Perhaps the highest cost of low interest rates over a long period is that it makes both savers and investors insensitive to the pricing of risk. Many small and not so small investors are putting their money in risky instruments in search of yield. I fret about the risks that many inexperienced investors, even in Malta, are taking by buying products that are non-investment grade.
Hopefully, they will be saved from the more serious consequences of their lack of experience.
The IMF as well as G20 leaders have warned about reliance on low rates. The IMF wants US and EU political leaders to adopt a three-pronged approach in their quest to stimulate growth. The first initiative is that of structural reforms in those economies that still suffer from archaic labour laws that discourage employers from investing and hiring more people.
Ironically, an attempt by the timid French government to liberalise employment laws to ease the employment of young people is being strongly opposed by French young people themselves who have taken to the streets to show their opposition to reform.
The second recommendation of the IMF is the continuation of the low interest rate regime for as long as is required – even if this is proving to be not so effective in creating increased consumer spending and business investment. But in the absence of bolder political initiatives the advantages of low interest rates outweigh the costs.
The third initiative that the IMF is proposing is a looser fiscal policy so that more importance is given to productive public expenditure to improve the social and economic infrastructure of countries that for decades have underinvested in the public sector.
The virtues of an austere fiscal stance may no longer be so visibly promoted, but the balancing act between the prudent management of public finances and the encouragement of spending on infrastructural projects is no easy task, especially for those countries that carry considerable public debt built over the last few decades.
The limitations of low interest rates as a tool to stimulate growth are undisputed. We have now reached a level where interest rates are already in negative territory and they cannot go down much further. Mario Draghi continues to insist that the ECB has other tools available – like the printing of more money to help governments and businesses to find the liquidity that they need to keep going. But few experienced economic analysts believe that the ECB on its own can bring about the much needed turnaround that will see EU economies growing at a more encouraging rate.
Things could become even more complicated if Britain decides to leave the EU in the June referendum or the migration crisis becomes even more daunting.
johncassarwhite@yahoo.com