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Monetary schism

19 September 2019

 Salomons Judgement

This column is not about Donald Trump’s battle to induce his central bank to lower the interest rates. It’s about the European Central Bank and its internal issues. 

Last week, the ECB went ‘all in’ again. Deposit rates become even more negative and the bond buying program will be restarted this November – within a year after the end of QE. I don’t expect any change in monetary policy in the short term; the ECB will ‘buy as long as necessary’, until inflation does what it should do. And that’s rising up to about 2%.

So, again free money in the eurozone. Investors are happy with the new stimulus program from the European Central Bank. Economists are a bit down. I am down. And I’m not the only one.

At the ECB offices, the decision wasn’t straightforward. An unprecedented number of board members was opposed to the decision to resume the debt buying. The opponents were from the major economies: Germany, the Netherlands and France. One central banker, Klaas Knot of De Nederlandsche Bank, was so resentful that he issued a press release in which he expressed his displeasure on the day after the interest rate decision. 

Knot’s criticism
The main criticism of Knot’s is that it’s not yet necessary for Europe to start buying bonds again. He also believes that there are good reasons to doubt the effectiveness of this monetary policy. I share the latter concern. This interest rate decision will not stimulate growth. I would rather think the opposite: people starting to save more money instead of less. 

So, should the ECB just lean back and do nothing then? Unfortunately, that’s no longer possible. Not after Draghi and partners told the financial markets that they would use a bazooka. As a fellow board member, you are left with no choice. That’s how I interpret Knot’s letter. I would be mad too.
 
The fact remains that the inflation target is out of reach. The frustration in Frankfurt about this is considerable. Besides bonds, the ECB mainly buys time with these new measures. Time that can, and should, be used for structural reforms and additional government spending. 

I’m under no illusions about this; the low interest rates obviate the need for reform, and countries with surpluses are still saving a lot. I see only a limited desire on the part of governments to use the available financial space. Until that time, we are stuck with a low interest rate. That’s how supply and demand works. But I don’t have to explain that to you.

The author

Roelof Salomons

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