I don’t envy Mario Draghi, being the head of the European Central Bank (ECB) must be difficult. That does not mean that I agree with his views on the European economy and monetary policy though. On Thursday this week the ECB announced its macroeconomic projections for the Eurozone for the coming years. Personally, I’d describe them as disappointing as the projections featured downwards revisions for most coming years when it comes to both inflation and economic growth. Perhaps more troubling is that the ECB has put off any rate hikes for 2019. What does this mean? Well for starters that nothing really changes until at least 2020. I think “lower for longer” is harmful to the economy as it makes it difficult for commercial publicly listed banks to stay profitable and it encourages unhealthy levels of debt for individuals and businesses, and remember individuals borrowing money to buy properties they couldn’t afford was a major part of what got us in to this mess in the first place.
Personally, I would have thought that the ECB would try something different given that their current policy seems unsuccessful. Draghi has soon been the head of the ECB for eight years without raising rates. Fair enough you might think, 2011 wasn’t exactly the perfect moment to raise interest rates and I’d agree. However, I’m rather worried that by postponing rate hikes the ECB establishes a new normal, akin to the situation in Japan where rates have remained at rock bottom for the last 20 years. If you establish this new normal then you can get some problems in the form of expectations. For example it’s well known in macroeconomics that peoples expectations of future inflation is a factor in how high or low actual inflation ends up being and by having a prolonged period where inflation is low despite central banks actively trying to increase inflation then its reasonable to expect future inflation to remain low, thus creating a vicious cycle. Furthermore, it’s hardly unreasonable to think that if there’s a prolonged period of low interest rates and low inflation that the economy becomes more sensitive to interest rate increases which might more or less permanently leave us in a situation where rates are low. This could create more problems but for now there’s only one potential issue with low interest rates I’m going to discuss.
I might very well be wrong but it does not seem implausible that there is a link between low interest rates and unethical behaviour by major banks. These two phenomena might seem wholly unrelated but if you think about it there might be a link. If central banks set interest rates low or even close to zero then banks will give loans with low interest rates, that’s the entire point and one of the main ways by which monetary policy works. However, it also makes it more difficult for banks to turn a profit given that they have to lend at low rates. This isn’t a problem in and of itself as it simply forces banks to adapt, the problem comes when these pressures are put on publicly traded banks. It’s difficult to give bad news to shareholders quarter after quarter and I personally think this might tempt some individuals who work in banks in to dubious activities with the bank’s money. Of course I don’t mean to blame central banks for money laundering or diminish the role of bad actors but I think a downwards pressure on interest rates really can be a factor in why some people at some banks decide to engage in those types of activities.
What do you think? If you want to share your thoughts on the subject feel free to contact me via Twitter @ipolecoblog. If you want to read more of my blog posts you can find the links to all of my posts on economics here and QE here. Come back next Sunday night for the next post!
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