In development cooperation, well-intentioned aid can sometimes make the situation in a developing country worse rather than better. Free goods can destroy local markets and create dependency among the population. The ECB's monetary policy has a similar effect. Via its programmes the ECB has bought up whole sections of the capital markets, largely distorting pricing in relation to risk. In addition private investors are driven into higher risk categories. The inevitable consequences are bubbles and misallocations. At the same time, over-indebted European states are becoming more dependent on the ECB’s low-interest-rate strategy and purchase programmes. As ECB money is so cheap, states are failing to pursue the necessary structural reforms and ensure adequate consolidation in their public spending. Because of this failure to act now, they will also be more dependent on cheap money in the future. Even the slightest increase of interest-rates increases therefore becomes an even greater political challenge. A vicious circle could ensue.
Collateral effects of the ECB policy are massive
The ECB decision last Thursday is thus bad news for Europe. As feared, the use of monetary policy instruments is being further relaxed, and the existing quantitative easing (QE) programme is to be prolonged. At least the ECB resisted the temptation to once again increase the volume of purchases, but even in its present form the purchase programme is neither necessary, nor does it make sense.
The collateral effects of the ECB policy are massive – and the longer the programme continues, the stronger the effects become. The ECB has justified its actions on the grounds of inflation being too low in the eurozone and on a weak growth environment. But in recent months – despite some notable differences between Member States – economic development has been improving and the outlook is cautiously optimistic. Inflation remains low primarily because of the ongoing effects of significant falls in the price of oil and other commodities.
Once these fundamental effects wear off in the coming months, inflation is expected to rise significantly again. Incidentally, the core inflation rate – which is the more important measure of price stability – is at an acceptable level of around 1%, and has been quite stable for months. There is no real justification for any concerns about deflationary tendencies in the eurozone.
Carrying on with the same monetary policy cannot be the solution, especially since the impact on private individuals is tremendous. Their provisions for old age and their savings are bound to be devalued. If the ECB adheres to its policy, this will be as detrimental to the system of funded retirement as the demographic change is for pay-as-you-go pensions.
Is the situation really so alarming that the ECB needs to strengthen its already extraordinary set of measures yet again? And what will the ECB do in the coming months if greater global uncertainty requires it to respond with monetary policy measures? The ECB's policy does not adequately support sustainable economic growth in Europe’s crisis states. On the contrary: public spending is not being sufficiently streamlined, structural reforms are being made – at best – at an excruciatingly slow pace, and the medium-term and long-term prospects for companies are correspondingly bleak. Under such circumstances, nobody is investing – regardless of how low the cost of borrowing has fallen. Even cheap-to-finance investments make no sense when there are no opportunities for reasonable returns in the long-term.
Governments reluctant to carry out reforms are going to sit on their hands
The collateral effects of the extreme relaxation of monetary policy are considerable. It was the ECB itself in its recent Financial Stability Report that addressed the risks within the context of strongly accommodative monetary policy. The German Bundesbank has also stressed the risks resulting from a low-interest-rate environment. Should these risks materialise, the road to a normalisation of monetary policy is likely to become even more rocky. The ECB would become captive to its own logic and responsibility – in terms of both price stability and financial stability. Carrying on with the same monetary policy cannot be the solution, especially since the impact on private individuals is tremendous. Their provisions for old age and their savings are bound to be devalued. If the ECB adheres to its policy, this will be as detrimental to the system of funded retirement as the demographic change is for pay-as-you-go pensions. But that ties in with the general trend of favouring debtors over creditors.
The law in Europe is at risk of being eroded, and the ECB is not helping by pushing the boundaries of its mandate. With its decision, the ECB continues to pursue the wrong course of action, instead of making a U-turn or at least holding out the promise of doing so. The ECB is sending the wrong signal. Governments reluctant to carry out reforms are now definitely going to sit on their hands and do nothing. In the USA, Janet Yellen has clearly indicated to the markets that the era of extremely cheap money will soon come to an end. Even if the situation in the eurozone is different, Europe urgently needs a similar signal. When it comes to low interest rates and quantitative easing, we should start talking about the beginning of the end.
The comment was first published in Frankfurter Allgemeine Zeitung, www.faz.net
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