Catch-22 for the Fed and the ECB

Central banks such as the Fed or the European Central Bank (ECB) are loosening their monetary policy. For example, the ECB has now reduced the size of its quantitative easing from 80 billion euros per month to 30 billion per month and the intention is that the bank will stop it completely by the end of this year.

The bank then wants to start raising the official interest rate in the course of 2019. Its sister institution in the US, the Fed, is already working on this. Interest rates have already been raised several times and the question for this year is whether the central bank will raise the key interest rate in the US two or three more times. She will continue with it in 2019, just like in 2020.

Crisis over
It is quite logical that, after years of increasingly loosening monetary policy, central banks are now moving in the opposite direction. The crisis is behind us, the danger of recession is small and the danger of deflation has faded away. This simply requires a different, less loose and therefore more normal monetary policy.

Another important reason for policy normalization is that central bankers know very well that the question is not whether another period of low economic growth or a recession will occur in the future, but when. Up and down is the natural movement of an economy.

Unconventional Resources
If such a period of weaker growth occurs while official interest rates are at 0 percent (ECB) or historically not far from that (Fed), then those institutions would have a major problem. They will then be unable or hardly able to counter the economic downturn with interest rate cuts.

The only thing they could do is revive quantitative easing (this is why I expect that unconventional monetary instruments will from now on be standard in every monetary toolbox, as recently described in detail in the IEX Profs magazine).

Quantitative easing
However, I would not be surprised if that provokes much more opposition than the quantitative easing used in the last crisis. First of all, because quantitative easing during the deepest recession in almost a century is very different from using quantitative easing during a period of lower growth. The recession of 2008 and 2009 was the longest and deepest since the end of World War II.

Secondly, there is the fact that many now know that there are also many and considerable negative effects of that policy, such as for savers and pensioners.

Catch-22
The central banks will want to avoid that confrontation and tackle a period of lower economic growth with interest rate cuts. And so, now that the sun is shining, raise interest rates sufficiently. However, that is easier said than done.

The ECB and the Fed are faced with a Catch-22 situation: they have to raise their interest rates to have ammunition to stimulate the next downturn, but the problem is that those interest rate increases in themselves can cause such a downturn before interest rates rise. are so high that they have significant room to stimulate.

Don't forget that the global economy has been dealing with (almost) 0 percent interest rates for more than a decade. This means, among other things, that it has become accustomed to being on a strong monetary drip and no one, including central bankers, knows how they will react if that drip is removed.   

Caution
With the above in mind, it would not be surprising if central bankers on both sides of the Atlantic very cautiously raise interest rates or that the process of policy normalization will take years.

Take the ECB: the first measure that we can classify under the heading 'unconventional' was the provision that commercial banks can finance themselves indefinitely at the ECB interest rate. We can therefore only speak of a normalized monetary policy in the eurozone if this measure is also reversed.

Long-term normalization
It is suspected that whoever succeeds Mario Draghi as the new president of the ECB at the end of 2019, will spend half of his 8-year term working on that normalization. And so that process, in the most favorable case, i.e. if there is no danger of recession in the meantime, will last until the middle of the next decade. The official interest rates of both the ECB and the Fed will peak at a considerably lower level than before the pre-crisis levels and will decline again from, say, 2020. 

Structurally lower interest rates than in the past and even more activist central banks. These are things that every entrepreneur should keep in mind when he is about to take out a loan again and considers which interest term to opt for.