Last week Mario Draghi, president of the European Central Bank (ECB), was in the Netherlands. He visited the House of Representatives, where financial spokesmen questioned him about the ECB's policy and its negative consequences. Consider the fact that today saving is a loss-making activity and pensions are being eroded.
That meeting, specifically the part where Draghi spoke, can perhaps best be described in two words: 'trust us'. We must have confidence in the ECB. The bank does what is necessary and the bank stops at the right time to prevent negative effects from prevailing.
The experiences with the ECB and the recent experiences with the central banks in the United States and the United Kingdom tell a very different story. A story with many consequences for interest rates.
Bank of England
Let's start with the latter, the Bank of England from London. That bank has the legal task of ensuring that inflation reaches 2 percent in the medium term (about 2 years). For example, it is not the bank's job to reduce unemployment. If the bank's forecasts show that inflation will be too high or too low in the medium term, the bank would have to raise or lower interest rates to achieve its target.
British inflation is currently 2,7 percent. That is too high, but what is really relevant for interest rate policy in the United Kingdom is what the central bank expects about inflation developments in the coming years. And the bank says that inflation will be well above 3 percent in the next 2 years. Nevertheless, the bank's interest rate committee decided (by 7 votes in favor and 1 against) to keep the official interest rate unchanged at 0,25 percent.
The US and the UK as examples
Why was that interest rate kept unchanged? Because the bank blames this high inflation on the weaker pound and because the interest rate committee must find a balance between the speed with which it returns inflation to the target rate and the support that the committee gives to the labor market with its policy. Trying to reduce inflation comes at the expense of employment.
Strictly speaking, the British central bank is thus breaking the law that the bank should adhere to. The legislator has instructed the bank to keep inflation at 2 percent and not to seek a balance between providing some support for the labor market or aiming for a certain unemployment rate.
On the other side of the ocean we see something similar. The Fed has a somewhat more extensive task than its British and European sister institution. The American central bank has the task of ensuring low inflation (approximately 2 percent price increases per year) and optimal employment. The latter equates to an unemployment rate of around 5,5 percent.
When the Fed lowered interest rates to 0 percent and began buying government bonds on a large scale (quantitative easing), inflation was below 0 percent and unemployment was about 10 percent. We now find unemployment in the United States at 4,7 percent and inflation at approximately 2 percent.
In short: it is high time for the Fed to stop buying government bonds and normalize official interest rates. The first one also happened. The Fed has chosen to stop buying government bonds. However, the interest and principal payments (from the previously purchased government bonds) are still used to purchase new US government treasury bills. In fact, the policy of quantitative easing is still going on, just on a much smaller scale.
Higher interest rates in the future
However, the second element: normalizing the official interest rate remains far away. The bank has indeed increased the interest rate, but at an excruciatingly slow rate. At least much slower than when she started lowering it. And everything indicates that making borrowing money more expensive will continue very slowly in the future.
Finally, there is the ECB. That bank must ensure an inflation rate of below, but close to, 2 percent per year. When the bank started buying government and corporate bonds en masse in the eurozone, inflation was slightly below 0 percent and the risk of recession was high. We now find annual inflation in the euro countries at 1,9 percent and economic growth since the beginning of 2015 has been higher than that in the United States. Yet the ECB keeps the official interest rate at 0 percent and says that the interest rate could be lowered even further in the near future.
The bank downplays this 2 percent inflation (which, according to ECB economists, will remain close to 2 percent for the next two years) by saying that inflation is not that high at all (if food and energy prices have been taken out). ). As if that matters to the ordinary man, for whom the ECB works. After all, price increases are price increases. Regardless of what causes it, the cost of living is climbing.
Why does all this matter?
On the one hand because it says a lot about the policy we can expect and on the other hand because it provides quite a bit of insight into the expected policy in the eurozone. Typically, European interest rates follow American interest rates, often with a delay and sometimes with a delay of several years.
The same applies to the policy of the ECB and that of the Fed. In concrete terms, this means that interest rates in the euro zone will remain low for the time being, but that a tipping point will be reached sometime in the not too distant future. Initially, long-term interest rates may shoot up. In the meantime, it is becoming very important to keep an eye on developments, otherwise the turning point will not be seen coming.