ECB must train with farmers

Recently I drove on the polder roads in Flevoland. Watering installations were on everywhere. Every agricultural entrepreneur knows that when it is too dry, he has to open the tap. If he doesn't, his harvest threatens to fail and his income plummets.

However, he must keep a close eye on whether that faucet should/shouldn't be opened and if so, how much. What he also knows is that if he gives too much water (or opens the tap when it's not necessary), he runs an equally great risk. Too much water causes the crop to drown. A typical case of it does not help, then it does harm. Our farmers know that. This is in contrast to our central bankers.

Money tap opened
When the eurozone experienced the worst economic crisis in decades on the one hand and the crisis in Greece erupted on the other, the European Central Bank (ECB) turned its monetary money tap wide open. In addition to cutting interest rates to 0%, the bank watered the bone-dry economic landscape in the euro country at over €30.000 per second.

That may still be plausible. Keeping the monetary tap off was not an option. This is because the eurozone economy would then collapse. However, the situation is now completely different. The economic growth in the eurozone is very similar to that of before the crisis. So high. Yes, it is true that there have been increasing signs recently that growth will moderate somewhat over the course of this year, but even then it will remain very high.

Yes, it is correct that the bank has turned off the tap slightly. That $30.000 per second has now fallen to around $11.000 per second, but that's still too much monetary liquidity for a fast-growing economy. And the interest rate will remain at 0% for the time being. The ground is now, so to speak, anything but bone dry in the euro country. Yet that monetary tap is still wide open.

Great danger
While that was reassuring news in recent years, it is now a major danger due to the radically different economic situation. The money tap is so wide that it threatens to drown. By drowning I mean that labor productivity remains low for too long. Low interest rates are keeping many zombie companies afloat. The disadvantage of this is that these less productive companies do take up labor and capital that would have more added economic value elsewhere.

Economic growth comes from the number of people who work and the productivity of those people. With the aging population, the first source is already in danger of drying up. So the second is more important than ever. It ECB policy however, holds back the much-needed stronger contribution from it.

Inflation
By drowning I also mean the danger of high inflation (in the long run). We know from the monetary past that too much money leads to higher prices sooner or later. The same past teaches us that high inflation is disastrous for our prosperity.

By drowning I also mean that bubbles can arise in the financial market. That sounds nice, because it means that stock prices will rise sharply and interest rates will remain low, but when those bubbles deflate (and that inevitably happens sooner or later), many households, companies and governments will find themselves in serious trouble.

What the ECB is currently doing is pursuing socially irresponsible monetary policy. The bank must therefore adapt its interest rate policy to the new economic reality much faster than it currently wishes.

Edin Mujagic

Edin Mujagić is an economist and manager at Beleggingsfonds Hoofbosch. He focuses on global central banks, and in his blogs he writes mainly about developments in interest rates and inflation. He has also written several books.

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