Mario Draghi, president of the European Central Bank (ECB), will hand over the keys of his office to Christine Lagarde at the end of this month. Draghi will go down in the history books as the first ECB boss to never raise interest rates. Will Lagarde be second?
Admittedly, it seems a bit strange to talk about Christine Lagarde's presidency when she hasn't even taken office yet. But still... If we assume that the ECB's inflation estimates are somewhat correct, then inflation until 2021 will be too low for the bank. Namely far away from the target: 'below, but close to 2% per year'. In other words: no interest rate increases until 2022.
The ECB expects the economy to continue to grow. For several reasons, a widespread recession in the euro area is not expected for the time being. But it seems to me as certain that a recession will occur sometime in the coming years as that the sun will rise every morning. Recessions are an inseparable part of economic development. You may be able to postpone it for a while with a lot of effort, but you cannot eliminate it.
Reach for the interest rate gun
In the event of a recession, it is expected that it will take even longer before inflation rises sufficiently for the ECB. Inflation and economic growth usually go hand in hand. Then we will be at least well into 2022, if not into 2023. If inflation in the euro area does start to rise after that, the bank will not immediately reach for the interest rate gun. The ECB does not work according to the principle of 'shoot first and then ask questions', but rather according to the slogan 'ask questions endlessly so as not to have to shoot'.
The bank wants to be more than 100% convinced that if prices rise by almost 2%, they will remain that way. Read: at 2% inflation, the monetary knights from Frankfurt will monitor the situation for a while. Happy 2024 has already sounded and we are rushing towards 2025.
Fingers on one hand
Only time will tell, but when we look back on her presidency at the end of 2027, the year in which Lagarde has to leave the ECB, I will not be surprised if the number of ECB interest rate increases can be counted on the fingers of one hand.
This suspicion is confirmed in a recent interview with Lagarde. In it she said, among other things, that central bank policy must be based on 'facts and economic data'. She wants to ensure that the ECB focuses on 'job creation, productivity and stability.' To be honest, she scares the hell out of me with that. Take the sentence that policy must be based on facts and economic data. Actions by a central bank, such as interest rate changes, affect economic growth and inflation with some delay.
Incentive with interest rate changes
There is quite a bit of time between the moment that a central bank makes borrowing money cheaper or more expensive for the banks and the moment that they pass on those interest rate changes to the consumer. It then takes some time before the end customer is stimulated by those interest rate changes to adjust his behavior. This means that a central bank by definition does not take action if economic data, such as inflation figures or figures on economic growth, show economic facts.
Due to the slowdown of the monetary mechanism, a modern central bank must therefore anticipate future developments. In other words: if you wait for facts and economic data, you are not just lagging behind the facts. You are pursuing the wrong policy. For example, if you lower interest rates, the economy will probably notice this when it recovers. As a central bank you therefore add fuel to the fire.
Braking too late
And if the ECB raises interest rates to slow down the economy, they will actually slow down (due to the aforementioned delays) when growth is already declining. Although… the latter does not have to be the case at the ECB under Lagarde. She said that the ECB must create jobs, boost productivity and ensure stability. That seems as if she believes that the ECB should not actually raise interest rates. Interest rate hikes slow growth, which destroys jobs.
Moreover, the question is how the ECB wants to create jobs and how the bank wants to manage productivity? Companies create jobs and they do so when economic prospects are good. The policies that Lagarde apparently advocates are more bad than good for economic development in the medium term. With a little imagination you can figure out how a central bank can create jobs, but that is particularly difficult with regard to productivity.
ECB is not eager
This is increasing due to better training, investments in research and education and modern infrastructure. Will the ECB take over schools and research centers and build 5G networks itself?
Someone needs to tell Lagarde what monetary policy can and certainly cannot achieve. Wanting too much means a great risk of wrong policies and undesirable economic outcomes. What Lagarde wants is worse than a central banker who says he wants high inflation. He or she will at least know what the central bank can and cannot do. What her monetary views tell us is that the suspicion that 'her' ECB is not eager to raise interest rates.