Have central banks reached the end of the line

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Kim Asger Olsen

Kim Asger Olsen


In the past months more and more voices have claimed that the central banks cannot do more to help economic growth. 8 years after the beginning of the financial crisis, growth remains anaemic across most of the OECD countries, and it appears that the “innovative” monetary policies of the past 6 years do not deliver as hoped.

I believe that there are at least two different issues involved: Does quantitative easing work? And does it have any negative effects?

Savers suffer
Beginning with the last of the questions there is no shortage of answers, particularly from Germany. Negative interest rates punish the savers, a well-known pillar of the German society. And when people cannot save and get a decent return, they do all kind of silly things with their money. The might even spend it.

This is exactly as it should be. Already in 1936, JM Keynes pointed out the misconception that the interest rates create an equilibrium between supply of and demand for money. Instead he argued that interest rates create the balance between savings and investment in society.

By keeping interest rates and bond yields low, central banks exactly try to discourage savings and to stimulate consumption and investment.

When the crisis started, private households slashed consumption, and companies slashed investments. Growth fell sharply, and the government deficits grew dramatically as tax revenues shrank and expenditure related to unemployment skyrocketed.

Governments – particularly the European ones - responded as they should not have done: They embarked on a program to stabilise the budget deficits through austerity programs. Predictably, this has caused the slowdown to last much longer.

The USA was a notable exception. The political gridlock there led to a budget deficit of nearly 10% of GDP. Allowing the automatic budget reaction to work allowed the US economy to recover much faster than the European economies.

Consumers appeared to have taken an important cue from the crisis: Do not over-leverage. Instead consumers have been saving or bringing down debt faster and for longer than expected. There has been much head-scratching why the sharp fall in petrol prices did not give a further boost to consumption. Various studies have indicated that consumers have preferred to save the windfall gain.

So, yes, it is correct that low interest rates punish the savers. It is in fact one of the purposes of low or negative interest rates. And it is positive for the economy which need more demand. Like in the ‘30s.

Delayed reforms???
Another German angle on the low interest rates is that it has damaged the “necessary structural adjustments”. David Folkerts-Landau, Chief Economist at Deutsche Bank has claimed that the accommodating monetary policy has allowed European countries to postpone structural reform.

Yes David, because politicians are not masochists and they have understood that once the neighbourhood is in flames, it is not the time to consider long term structural changes to the organisation of the fire brigades.

Folkerts-Landau’s remark is a good example of the ideology behind Germanys powerful backing of austerity programmes in Europe. Politicians and the people need to feel the negative effects of their wayward spending in order to make them understand that things must change.

If Spain suffers from a 25% unemployment, I just wonder whether the governments should have accepted 30 or 35% unemployment?

Germany had its period of fascism. Unfortunately, Germans do not see that imposing austerity policy has created a fertile ground for European ultra-right wing and national conservative politics that will haunt the continent for decades.

So, no, the central banks have not given the governments an excuse for not cutting even deeper. If they have done anything, they have softened the blow from an ill-conceived policy that makes the recovery more difficult.

But for ideologists, facts do not matter.

Banks in trouble
Folkerts-Landau works for a German bank in deep trouble, Deutsche Bank. DB is so badly off that he has suggested that EU bend the rules in order to help the European banks with a proper bail-out. On this point he is in direct disagreement with the German government.

But the focus is right. Europe’s banks are still a disaster and here comes the rub: ECB’s policy is contributing to the malaise.

ECB has forced negative interest rates in order to discourage savings. Banks with excess liquidity may place the money in the central bank or in the money market – and pay for it. Due to the public backlash against banks, the negative interest rates have not been passed on to retail clients. Add that commercial loans are not really a growing business. It means that the banks currently are under heavy pressure on their basic business, receiving deposits and providing loans.

Add that many European banks are still dragging bad loans along. It means that their capital buffer is weak and that they are badly prepared for a situation of a negative interest rates.

But is ECB (and Bank of England) to blame for this misery? Well, no, since they are completely innocent in the pussyfooting around the banks. Local authorities have not really pushed the banks to clean up in a misunderstood attempt at keeping the banks’ owners and management happy. The Nordic countries have learnt from their mistakes in 1992 and today have healthy banks.

Many European banks are still way too vulnerable. And they suffer badly under the negative interest rates. But ECB for sure is not to blame.

It is in other words clear that ECB’s (and other central banks’) policy has some consequences that not everybody likes. And it may indeed be right that the central banks do not have a lot more ammunition. But the issue is misdirected. The question is not whether the central banks can do more. It is why the (European) governments are still sitting on their hands, 8 years down the road.