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Opinion

Opinion: ECB monetary policy runs amok

The European Central Bank's decision to leave interest rates near zero shows little sign of helping the real economy. The cheap money policy is causing more harm than good, DW's Rolf Wenkel thinks.

The leading interest rate at which the European Central Bank (ECB) lends money to commercial banks for overnight loans has been at 0.05 percent since September - a historic low. Commercial banks continue to be in a position to borrow money practically for free. However, for the past few months, banks have had to pay an interest rate corresponding to an annual rate of 0.2 percent to park excess reserves at the commercial bank overnight - and as of Thursday, they'll have to pay 0.3 percent.

The ECB's aim in charging commercial banks a bit more interest on overnight reserve deposits, or "excess liquidity" in banking jargon, is to increase the pressure on them to extend credits to industry and commerce instead of parking it at the central bank. In reality, all the policy will do is make banks' money managers sweat a bit at trying to avoid holding excess liquidity at the end of each banking day. Real-economy lending won't be stimulated effectively.

In addition, the ECB has announced it will extend its massive bond purchase program by at least six months. It will run "until the end of March 2017 or longer," ECB president Mario Draghi has announced. Originally the program, which the ECB calls an "expanded asset purchase programme," was set to expire in September 2016.

By using its almost infinitely flexible balance sheet to buy government and commercial bonds from secondary bond markets - i.e. bonds held by institutional investors and commercial banks - ECB is pumping about 60 billion euros ($65 billion) into financial markets, generating a huge flood of excess liquidity which investors then turn around and re-invest in other financial assets, such as stocks or real estate, driving their prices up.

Let the horses guzzle

Karl Schiller, who was federal minister for economic affairs from 1966 to 1972 in the Cabinet of then West German Chancellor Kurt Georg Kiesinger, famously said when he was sworn in to the job that the goal of his economic stimulus policies would be to "let the horses guzzle again." What he discovered is - as the great British economist Lord John Maynard Keynes once said - one can lead the horses to water, but one cannot force them to drink.

In other words, it's pointless to continue pouring more water into a drinking-trough that's already full to overflowing. But that's essentially what Mario Draghi is doing by pouring even more liquidity into financial markets that are already awash with money. He's determined to fight below-target consumer price inflation by relentlessly increasing liquidity.

But the problem is that real-economy businesses and entrepreneurs - in our metaphor: the horses - simply aren't looking to borrow or invest more than they're already doing, economic growth remains anemic, and the eurozone consumer price inflation (CPI) rate is staying stuck near zero. In October and November, the CPI rate was just 0.1 percent.

Rolf Wenkel

Rolf Wenkel is DW's long-time senior economic commentator.

The specter of deflation

The ECB sees the ideal value for inflation as being just below 2.0 percent. That's its target CPI rate. If the CPI rate goes to near zero or even goes negative - i.e. if consumer price deflation breaks out, and goods and services get cheaper in nominal terms - alarm bells ring at ECB headquarters. The reason: Business and consumers might decide to delay major investments or purchases in anticipation of goods getting even cheaper. The result would be a reduction in economic activity, a potentially self-reinforcing deflationary spiral - which is what happened during the Great Depression of the early 1930s.

But the ECB's ultra-cheap lending policy is having less of an impact than the ECB initially had hoped. The eurozone economy is returning to growth very slowly. The horses aren't guzzling. The German economy is a case in point: it's growing at a moderate pace, with stagnating or sinking exports into emerging-economy markets offset by rising exports to the European Union. Businesses are hesitating to make big investments in plants or equipment, and whatever degree of moderate growth the economy is experiencing is a result of a moderate increase in spending by German consumers - a phenomenon that has little or nothing to do with ECB's tsunami of financial-market liquidity, but rather reflects recent increases in wage packets.

Running amok into emptiness

Draghi's policy reaction to the perceived threat of deflation is also entirely overdone. At the moment, the main reason prices aren't rising is simply that oil prices have been very low recently. Underlying trends in the core inflation rate, when the impact of energy prices is removed, are stable and no cause for concern.

Despite this, ECB is intensifying its existing liquidity-tsunami, rather than initiating a gradual return to normal monetary conditions. Yet economists have increasingly been saying that the currently very low inflation rate doesn't require any additional ECB "expanded asset purchase programme" measures, since they're having little or no discernable effect.

In fact, they are having a discernable effect - although not on the volume of lending to real-economy businesses, as Draghi hopes. The actual effect is, instead, to increase systemic risks in the financial sector. The financial system is becoming habituated to the flood of money pouring from the ECB month after month, and to the unnatural situation of negative interest rates, and this is leading to an increasing risk of speculative bubbles.

Managers of large financial capital pools, in their daily search for high-quality investible assets - of which there is a limited supply facing an ever larger quantity of "liquidity" looking for a return - are being forced to turn to ever riskier, lower quality investments in an effort to find a positive short-term financial return. Meanwhile, ordinary savers essentially can't get an interest rate paid on their savings.

One could almost feel pity for Mario Draghi. He believes he needs to do something with the monetary policy levers at his disposal. The European economy is returning to growth, albeit slowly. One suspects that it would be doing so in any case, even if ECB weren't running amok in a monetary-policy rampage, led by an ECB president driven by illusory visions of evil deflationary spirits.

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