Is the euro-crisis over? Definitely, not! Just consider the remarkably low level of interest rates in many industrialized economies. The US government can borrow at about 0.5 percent interest rate for five years, and at 1.5 percent for 10 years. The rates in Germany are similarly low, and they are still lower in Japan. These low rates – even on long-maturity loans – mean that markets are offering the opportunity to lock in low long-term borrowing costs. What does all this tell us about macroeconomics and monetary policy?
Many economists both in the US and Europe argue that further interest rate cuts will almost certainly be ineffective. We are simply at the lower boundary, and further cuts will bring no big additional stimulus. In fact, one has to wonder how much investment businesses are unwilling to do at these extraordinarily low interest rates. The fact that the economy remains sluggish despite these low interests rates points to a continuing crisis of confidence. As long as we have an overreliance on private and public debt and the deleveraging process is not over, we will remain in this crisis. Further borrowing will simply increase the anxiety about the creditworthiness and not solve anything. Thus, I argue – contrary to widespread belief – that monetary policy is not a solution in the present situation. The firepower of central banks is not unlimited, especially in a monetary union.
First and foremost, a central bank – like the European Central Bank – has to protect its independence. Funding private banks against inadequate collaterals would shift substantial burdens between national taxpayers and undermine the ability of central bankers to protect their independence. Financial transfers are the job of fiscal policy. In addition, the European Central Bank also violates the terms of its own mandate.
Second, if interest rates stay too low for too long, we ignore the lessons learned before the onset of financial crisis of 2007 to 2009. The architects of monetary policy have to make sure that they are not preparing the ground for the next bubble. Interest rates near zero, combined with massive liquidity interventions, do not come without medium-term and long-term side effects. There is evidence that the current policy encourages more aggressive risk-taking and maturity transformation. Monetary policy needs to become more symmetric over the business cycle to prevent the build-up of financial imbalances.
Third, the current policy makes private banks overly reliant on central bank funding. This reduces and delays incentives to reform a financial sector that still draws on bas business models. The experiences of Sweden and Japan illustrate the risks of delayed actions: both countries experienced a banking crisis in the early 1990s and initially delayed the reform process. Not surprisingly, both countries ended with a lost decade.
It may be appealing to policymakers to abstain from unpopular reforms and hope for more monetary accommodation from central banks. However, monetary policy ought to remain independent, and it is effective in the short-run only. Additionally, the ultimate goal of European monetary policy – as specified in the mandate of the ECB – is not full employment and growth. It is financial stability and, most importantly, price stability. All standard and non-standard monetary policy measures such as the current long-term refinancing operations, are temporary. Overburdening monetary policy does not provide solutions for the Eurozone and does not solve the current sovereign debt crisis.
This is my last column for The European Magazine. Thanks to all readers for comments and discussions.
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