The European Central Bank (ECB) surprisingly reduced all of its interest rates Thursday and confirmed that it would be launching two new stimulus programs aimed to reinvigorate the fledgling eurozone economy, a move that appears to be from the playbook of certain past Federal Reserve Chairmen.
ECB president Mario Draghi said that he has slashed the rates to record lows: 0.05 percent for refinancing (from 0.15 percent) and -0.20 percent for deposits (from -0.1 percent). In addition, the two new programs will purchase asset-backed securities and covered bonds allocated by eurozone financial institutions. These monetary policies will commence next month and further details will be given soon after the governing council’s meeting on Oct. 2.
Draghi noted that the central bank can’t possibly lower its interest rates any further.
Financial analysts say both moves are astonishing and are signals that economists are not pleased with the sluggish eurozone economy and the threat of low inflation, which they say has been going on a lot longer than anticipated and could risk hurting the rehabilitation efforts of the regional economy.
“In August, we see a worsening of the medium-term inflation outlook, a downward movement in all indicators of inflation expectations,” Draghi said in a statement. “Most, if not all, the data we got in August on GDP (gross domestic product) and inflation showed that the recovery was losing momentum.”
The ECB head assured markets that it is able and ready to offer any additional stimulus through “unconventional instruments within its mandate,” such as the means of bond acquisitions, otherwise known as quantitative easing, a measure that the United States started during the economic collapse.
Draghi averred that the governing council had been discussing such a measure for a little while, and some members were in support “of doing more” and others were in favor of doing less. Several members, meanwhile, absolutely opposed the rate cuts.
As it was purported in June when the ECB first reached negative interest rates, this move could backfire as consumers will refrain from depositing funds into the banks and look for safer assets that protect their wealth. This means that financial institutions would have limited capital available in the system to lend out to businesses, and thus cause significant stagnation and an even further drag on the economy.
Another problem is that this move will definitely lead to devaluation of the euro. Although the primary objective of this type of monetary policy is to spur consumption, it’s difficult for consumers to spend when their purchasing power has diminished and eventually eliminated.
When Scandinavian central banks attempted to incorporate negative interest rates, it was a disastrous policy because their respective currencies’ value eroded and they have yet to recover from the experiment.
Harvard economist N. Greg Mankiw stated at a 2010 Boston Fed conference (via New York Times):
“What a depositor is going to do is say, ‘Well, if they’re going to charge me money to keep my money at the bank, I’m just going to keep my money at home,’ and the only thing you’ll generate is a demand for safe assets — and by that I mean . . . they’re going to be buying a bunch of safes so people can put their money in their safes rather than in the bank.”
Governments will also be impacted negatively in the long-term. As a growing number of federal, state/provincial and local governments borrow more money and go deeper into debt, their interest costs will be lower in the short-term, However, since politicians and bureaucrats never think of the future, when interest rates start to spike then their debt service payments will skyrocket and lead to a financial collapse.
As Mises.org’s Dickson Buchanan wrote last month:
“Could all the pseudo-academic speak be a disguise for the real objective: Central banks exist to make it easier for insolvent governments to borrow more money.”
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