<\/p>\n
Daniel Gros writes: \u00a0\u00a0Stubbornly low inflation has the European Central Bank worried. But its response \u2013 essentially just more quantitative easing \u2013 could backfire, exacerbating imbalances and generating serious financial instability.<\/p>\n
As it stands, the headline consumer price index in the eurozone hovers around zero, and even core inflation remains below 1%.<\/p>\n
Instead of rethinking its strategy, the ECB is considering doubling down: buying even more bonds and lowering its benchmark interest rate even further into negative territory.<\/p>\n
Easier credit conditions and lower interest rates are supposed to boost growth by stimulating investment and consumption demand. But in the core of the eurozone \u2013 countries like Germany and the Netherlands \u2013 credit has been plentiful, and interest rates have been close to zero for some time, so there was never much chance that bond purchases would have a significant impact there.<\/p>\n
Of course, in the highly indebted peripheral countries, there was room for interest rates to fall and for credit supply to grow \u2013 and they have, leading governments and households to increase their spending. While the asymmetrical impact of the ECB\u2019s policy is appropriate in principle, recovery supported by the least solvent economies is not sustainable.<\/p>\n
Back in 1986, Hyman Minsky warned about the longer-term dangers to financial stability if \u201cPonzi\u201d borrowers \u2013 those who can service their debt only with new debt \u2013 become the main pillar of the economy. A zero-interest-rate environment is of course ideal for such borrowers, because there is nothing to provide an indication of solvency; borrowers can just roll over their debt.<\/p>\n
The standard response to Minsky\u2019s concern \u2013 that the spenders can\u2019t afford it and the savers aren\u2019t spending \u2013 is that monetary policy should focus on ensuring price stability, while macroprudential policy aims to safeguard financial stability by limiting borrowing by highly indebted agents.<\/p>\n
After the 2001 recession in the US, although the Federal Reserve kept interest rates low for a protracted period, the corporate sector did not increase its investment. The recovery was ultimately fueled by so-called \u201csubprime\u201d mortgages: home-purchase loans extended to borrowers with lower credit ratings. The result, as we know, was a mega-bubble that triggered the 2008 financial crisis.<\/p>\n
In the eurozone\u2019s case, the risk is compounded by the ineffectiveness of its key macroprudential limiting countries\u2019 spending, as lower interest rates give debtor countries leeway to spend more. Public debt as a share of GDP is on the rise in Italy and Spain, even though both countries, with their eurozone partners, have committed to reducing the debt ratio.<\/p>\n
In short, monetary policy is perpetuating the disequilibrium between creditor and debtor economies in the eurozone, and macroprudential policy is doing nothing to stop it. When interest rates normalize, this could generate serious financial instability. But \u2013 and this is the conundrum \u2013 the ECB has few options for stimulating demand among the eurozone\u2019s more solvent agents, and thus supporting a sustainable recovery..<\/p>\n
A recovery has already begun in the eurozone. It should be left to run its course. An even more expansionary monetary-policy stance might strengthen the recovery marginally, but at the cost of increasing the eurozone\u2019s already-dangerous imbalances.<\/p>\n
Daniel Gros writes: \u00a0\u00a0Stubbornly low inflation has the European Central Bank worried. But its response \u2013 essentially just more quantitative easing \u2013 could backfire, exacerbating imbalances and generating serious financial instability. As it stands, the headline consumer price index … Continue reading ![\"Uncle-Sam-Running-on-Zero-Percent-Interest-Rates-cartoon\"](\"http:\/\/www.w-t-w.org\/en\/wp-content\/uploads\/2015\/11\/Uncle-Sam-Running-on-Zero-Percent-Interest-Rates-cartoon-300x246.png\")
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