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Interest Rates Are Low, So Let Us Reduce Them!

Economic growth does not get into gear yet. Declining prices for oil and materials have hindered economic growth. Consequently, official forecasters have reduced their growth expectations for the current year. Parallel to this, inflationary expectations tilted downwards. Eurostat even reported a deflation of 0.2 percent in the month of February.

Mario Draghi, the President of the European Central Bank (ECB), made it clear that he would not hesitate to expand the policy of quantitative easing (QE) if necessary. Location was the European Parliament. Now these are firm words; but should an expansion of QE be seen as a real exploit? Unlike spending and tax policies of a national government, a change in ECB’s monetary policies does not require approval by a parliament. Similarly, unlike spending and tax policies of a national government, a change in ECB’s monetary policies does not require much preparation. Rules and laws do not need to be adjusted, only the number of financial transactions should be increased, which, disrespectfully speaking, boils down to just some more mouse clicks.

However, more important than the language is the policy proposal. This calls for two qualifications. The first concerns the benefits of QE. According to Draghi, these are huge: calculations made by the ECB would have shown that half of the economic recovery in the euro area in 2014 and 2015 is to be attributed to ECB policies. That is a nice result. At the same time, it seems at odds with what we observe, to say the least: inflation and economic growth did not improve remarkably since central banks in the euro area started to buy bonds. However, to be sure to avoid drawing wrong conclusions, we should rely on econometric research.

But such research is difficult, given the scarcity of data. The ECB started its QE program only in March last year. This time period is way too short to be able to find robust results. Analyses of other countries are also scarce: worldwide, QE is a new form of monetary policies. The Bank of Japan introduced it in 2001 and the Fed, the Bank of England and the ECB only after the financial crisis of 2007/2008. What are the findings of the few econometric analyses of QE? An analysis regarding QE policies of the Bank of Japan states that the effects of these policies upon aggregate demand and prices have been small. An analysis of QE policies in 2009 and 2010 by the Bank of England indicates that it exerted little effect: GDP increased with only 1.5 percent and inflation increased not more than 1.25 percentage points.

The second qualification concerns the costs of QE policies. In the euro area, low interest rates have reduced income available for private consumption. This effect may be even stronger in the Netherlands due to its large share of contractual savings in the economy. Obviously, weak private consumption is little helpful for economic recovery. Moreover, low interest rates induce investors to switch their portfolios towards other financial assets such as high-risk equity. This may add to the risk of new bubbles on these equity markets, a development that one would like to avoid in light of the recent financial crisis (see also the report by the Bank for International Settlements). A third problem of low interest rates is the economic behavior of national governments. Noting that QE policies make debt accumulation cheap, these governments are induced to delay policies of debt reduction, again a development that one would rather not see happening.

The ECB Governing Council will have its next meeting March 10 this year. Let us hope that, rather than firm words, an assessment of costs and benefits will form the basis of the decision on whether or not to expand QE policies in the euro area.


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