Last week Mario Draghi, the outgoing president of the European Central Bank, announced that the ECB had decided to cut one of its key interest rates, the one charged on bank deposits at the ECB, to -0.5 per cent to encourage lending.
One needs to appreciate that here we need to look at the bigger picture. It may be that banks in Malta do not need encouragement to lend further as the economy is performing very well. However, when one looks at what is happening in the eurozone as a whole, one notes a general economic slowdown.
The ECB also announced that it had left its headline borrowing rate at zero but pledged to leave them alone indefinitely, until inflation has robustly risen. This means low interest rates are here to stay for some time yet. It had also decided to restart its quantitative easing programme in November, with €20 billion of bond purchases each month. Finally, it said that it had made its offer of cheap loans to banks more profitable.
Whichever way one looks at it, this is certainly a loose monetary policy aimed at stimulating economic activity in the eurozone. Students of economics know that the objective of monetary policy is to control the quantity of money in the economy and the channels by which new money is supplied, through the management of liquidity in the economy and interest rates. Monetary policy uses these tools to stimulate or bring under control the rate of inflation, consumption and economic growth.
The stance of the ECB is clearly one where it is keeping interest rates low and buying bonds in order to enhance the level of liquidity in the eurozone economy to stimulate consumption and investment.
This decision of the ECB immediately drew a negative reaction from some quarters. There was gossip that certain members of the governing body of the ECB were opposed to restarting the quantitative easing. German bankers criticised this decision as it will eventually end up hurting savers and the banks’ customers base in general.
US President Donald Trump claimed that the ECB was deliberately seeking to weaken the euro by lowering interest rates to help companies sell goods overseas. Draghi quickly rebutted this claim as he insisted that he was simply following his mandate, which does not include currency depreciation.
Draghi defended the decision of the ECB by stating that the risk of a eurozone recession has risen, with many economists believing that Germany’s economy is already shrinking. He also hinted that the economic growth of the last few years, following the severe international recession, was the result of the ECB’s loose monetary policy.
Governments had not done enough in terms of fiscal policy to stimulate the economy. Some have interpreted Draghi’s comments as being a message to eurozone governments to borrow more to encourage growth.
There were also people who praised the ECB for its decision. Their attitude is that with the continual threat of trade wars, the Brexit mess and the adjustment process through which the Chinese economy is going are all threats of turbulence in the markets. These developments, especially the threat of trade wars and the uncertainty over Brexit, is forcing companies to delay their capital expenditures, until matters become clearer.
This decision of the ECB encourages governments (more than it encourages businesses and consumers), to finance a modest fiscal expansionary policy and to make use of any fiscal space they may have. One such country is Germany, which is being told that now is the time to increase public spending.
The vice president of the European Commission, Valdis Dombrovskis, was on record saying that the German government should now look to ease its rules on fiscal spending in an effort to bolster its flagging economy.
It is also known that some EU member states are now seeking to obtain more flexibility within the parameters of the current fiscal rules, to adopt an expansionary policy. For example, Italy is claiming that any expenditure in the so-called green economy should not form part of the fiscal deficit.
The figures clearly show that the growth forecast for the eurozone for 2019 is well below the average annual growth rate of the previous five years. The prospects for China and the US for 2020 are not any better. We, therefore, do need to look at the bigger picture if we wish to minimise the risk of another severe recession, which is what the loose monetary policy of the ECB is doing.
Lawrence Zammit’s article was published first on The Times of Malta print edition.
