Since Mario Draghi announced measures to further ease monetary policy, criticism has mounted with many pointing to the downsides of negative rates: struggling banks, meagre returns for savers, artificial lifeline for unprofitable “zombie” companies, property bubbles. Some also doubt whether such policies can genuinely boost investment, which is actually driven by full order books rather than cheap finance. Finally, others challenge the need for a 2% inflation target which seems largely irrelevant. All these objections are well-founded and legitimate, but do central banks, and the ECB in particular, actually have any other policy option?
After a decade of continuously falling yields, the world's economic agents are up to their necks in debt and any serious hike in rates would trigger a global recession. Normalising monetary policy would create problems on many fronts: governments and companies would struggle to refinance, the property market would correct, stock markets would plunge and financing and liquidity on credit markets would dry up, squeezing investment and consumption.
Only when the economy is growing strongly can central banks safely dismantle their highly accommodative policies. Then, economic agents could easily absorb higher costs of financing. The 2017 surge was such a window of opportunity and central bankers mooted a normalisation of policy from 2018, which the Fed in fact began in the second half of 2018. But even as they did so the window was closing, with the intensification of the US trade offensive and inherent problems of the Chinese economy. The possibility of normalisation was choked off and markets fell sharply in the last quarter of 2018.
All of which suggests that, in the current climate of slowing global trade, central bankers probably have no other option but to continue their accommodative policies. Faced with the certainty of recession on one hand and the collateral damage of negative rates on the other, the monetary masters have made their choice. There will yet be time to unwind these policies when the environment is more propitious.
Article completed on 17 September 2019 by Florent Delorme, macroanalyst at M&G Investments.
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